Old school financial advice will tell people you must do everything to steer clear from debts, all kind of debts. While the intention is good, it can also be a blunder towards leveraging debts to create wealth. While middle income families are leaning towards bad debts, the financially literate are using other people’s money to create more money for themselves. This is where the middle class is beaten when it comes to building up net worth overtime.
So what makes a debt good or bad?
Good debts can create income for you so that it pays for itself. If a debt will give you good financial return in the long term, then a debt is considered “good”. Here are some examples:
1. Education – college loans are considered good debt because it adds personal value through skills and competencies. College graduates can land better paying jobs compared those who did not make the same investment for education. Educated people also have more opportunities coming their way making the investment worth it as the earnings through the years easily pay off the original amount of the loan plus interests.
2. Opening a small business – taking on a loan to open up a new business is considered good debt because the business will eventually earn and provide the cash flow to pay up the debt. And when the loan is all paid up, the income continues.
3. Real estate – loaning money to purchase a property is also a smart financial move. For many this is just to buy a home for the family, sit on it for years hoping its value appreciates, and then hoping still that the mortgage is cheaper than paying rent. The better approach would be to secure properties and earn from it through rentals.
4. Investments – borrowing money from the bank to invest in stocks, bonds, futures, commodities and even precious metals is another example of a profitable debt. It all boils down to your tolerance for risks. The higher the risks, the higher the possible returns. On leveraged money, taking risks is part of the equation of getting the most out of the loan.
Bad debts give you nothing but expenses, often times with repayments you cannot afford. Swiping your credit card for the latest game console is a very good example of a bad debt. You simply took out a debt for something that will surely depreciate with time. And credit card debts are the worst out there.
Taking on a car loan is also considered a bad debt. While the car is a necessity for many people, it is worth less than it was seconds ago when you drove it out of the showroom. And you are paying interests for it! Be sure to get the least expensive car out there.
Other bad debts include those that are used to buy clothes, consumables and services.
The probability of success
There is still a need to approach debt, even the good ones, with caution. Be intentional with your loans. Be prudent – take on smaller loans and grow into the industry you plan to get into. If it’s property rental, start buying small properties, and then know the business, understand how it all works and then re-invest if you are confident enough., this time taking on a bigger loan. This will increase your probability of success. This way you maximise good debts and let it create income for you.