What debts are bad debts? Can there be good debts at all? I know that the topic of this article can be confusing to some people. The decision whether certain debts would be described or categorised as bad debts or good debts will be taking out of accounting or business context. We are going to be looking at it in the perspective of personal finance. To accountants, bad debts will mean the debts which cannot be recovered from customers. But that is not the meaning we shall be focusing on. The debts here are not the amounts that other people are owing you. Instead, the debts represent what you owe. This can be student loans, car loans, mortgage, credit card balances and other credits.
To begin with, I will like to ask you some questions. What type of loans do you have? Or, how many types of loans do you have? Why did you borrow the money? Did you exhaust all available options before you resorted to borrowing? How much is involved? Is it the minimum amount you needed or you borrowed based on the amount made available to you? Do you have a well-structured repayment plan? Could your income level support the repayment amount? The questions can be on and on. But your answers to these questions can provide a clue as to whether your loans are bad debts or not. To be more explanatory, the following are the characteristics of bad debts:
Purpose: What is the purpose of the loans? Why did you borrow the money in the first place? If you borrow money just because you want to enjoy yourself, that is, you just want to feel good, I will say that such loan is a bad debt. Why should you borrow for vacation trips? Must you engage in such expensive trip? Can’t you look for cheaper way of enjoying your vacation? If you can’t afford a particular hotel room rates, you can choose the less expensive hotel. If you can’t afford the flight tickets, why can’t you travel by road to a nearby location? The truth is that, if you think that a particular place is not appealing enough, you will meet people there who will be happy that they visit the place. I don’t want to digress too much. If the purpose of the loan is not contributing to you in any way, definitely you may be accumulating bad debts. You can’t compare someone borrowing for the purpose of embarking a vacation trip with someone borrowing to start a business or to finance his college fees. Borrowing to start a business or to finance educational fees can be seen as investments while borrowing for vacation is just an expense. While investment can pay up a loan, you will need to make income from somewhere in order to pay loans you spent on meeting certain epoenses.
Timing: There is saying that “delay is not denial”. Ask any successful person, he will tell you the importance of delayed gratification. There are many people who are deeply into debts today just because they cannot exercise patience. They like to have everything immediately. A person just graduating from the college wants to ride the best latest car. There is something about this life. Life is like a ladder. If you jump a rung, you may need to come back to it. So, if you borrow at the wrong time, you may end up accumulating bad debts as you may not have the ability to pay back the loan. If a student can work for some time and make some savings before buying a car, he will not need to depend too much on auto loan to finance his car.
Amount: Some loan companies are willing to give you as much loans as possible if they know that your income can support the repayment. But if you borrow just because banks are ready to give you loans, you may lavish the loans on irrelevant things. Before you take any loan, you need to ascertain the amount you really need. For instance, you may have justifications for student loans. But the question is, are you borrowing the minimum amount you require or you are borrowing the maximum you are qualified for? It is easy to borrow but it is not always easy to repay. If you borrow beyond what your salary can conveniently pay back, there may be too much pressure on you. Your inability to repay your loans may lead to default thereby deteriorating your credit score.
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In summary, bad debts may not have a specific definition, what represents a bad debt to one person may be a good debt to another person. But if you analyse your situations especially based on the above criteria, you will be able to ascertain whether you are carrying bad debts or good debts.