Know The Difference Between Good Debt and Bad Debt

|Posted by | Banking, Money Matters, Money Tips, Personal Loan

Know The Difference Between Good Debt and Bad Debt

Before taking out any loan, you should know if it will be a good or bad debt for you. Don’t know how to differentiate between the two? Find out how a debt can be good or bad, and learn how to manage your debts wisely!

What is A Good Debt?

A recent research study showed that 68% of Malaysian’s are currently in debt, with most of these debts being incurred due to high living expenses, rental payments and children’s education. And with the surging increase of Malaysian household debt, Bank Negara Malaysia has now introduced stricter lending rules in order to contain the situation. According to AKPK, most Malaysians who seek financial help from them usually cite overwhelming credit card debts.

See also: Manage Your Debts For Free in Malaysia with AKPK

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By definition, debt means you borrow money from another individual or from a financial institution for a period of time for which you will later pay back the amount you borrowed along with interest. For most of us, taking on debt via loans is necessary because we often don’t have enough cash to make essential purchases. What makes debt good or bad is defined by the impact that it will cause in your financial life; whether the impact is positive or negative.

Good debt is one that helps to enhance your financial position over a long (or even short) period of time. There should also be clear and specific reasons behind you taking out the loan. For example, taking out a loan to grow your business makes it a good debt as the loan will help to increase your net worth. Good debt can also be characterized as below:

  • Increases and adds to your net worth
  • Helps your money grow
  • Affordable repayment
  • Low interest

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Examples of good debt

Education loan

A survey ranked Malaysia as the fifth most expensive country for higher education – which explains the reason why many Malaysians are in debt due to financing their children’s education. Granted, higher education can be a pricey affair and this can lead to parents or even students having to take up loans to finance their studies.

However, as David Bok a former Harvard President said, “If you think education is expensive, try ignorance.” Having higher qualifications helps secure better jobs and then increases future earning power, so as an investment; taking up an education loan is a type of good debt.

Investment Loan 

Taking up a loan so you can put it into investment vehicles such as a fixed deposit or Amanah Saham Bumiputera (ASB) can be a good investment, provided you know what you are doing. The main rule is to ensure that what you earn from the investment will be more than the interest or expenses incurred to you for the loan.

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What is A Bad Debt?

Bad debt is characterised as a type of debt which does not add any financial value to your life. Aside from that, a bad debt can also be one which costs you more money in the long run. Other characteristics of bad debts include:

  • Buying items that decrease in value over time such as a car.
  • Credit card debts that are not paid on time.
  • High interest loan which causes you to pay more than you should.

An example of bad debt

Credit card debt

A credit card can be a powerful financial tool, if used correctly. However, it can turn into a bad debt when you use it to make large purchases but only make the minimum payment each month – or worse, pay it AFTER the due date. These will incur unnecessarily high charges and interest, not to mention risking a bad score on your credit report.

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Tips To Manage Debt Wisely

Contact your loan provider or bank immediately when you have difficulties meeting your loan repayment schedule. Chances are the banks will be open to negotiations as they will also want to minimize the chances of a non performing loan (meaning you don’t pay your loan at all). So before things get messy, try to work something out with your bank.

Alternatively, you can also reach out to Agensi Kaunselling dan Pengurusan Kredit (AKPK) also known as the Credit Counselling and Debt Management Agency which was established by Bank Negara Malaysia. Their services are free and they offer counselling and advice on financial management and also assist individuals with their debt problems through their Debt Management Programme.

Before taking up a loan, compare loans from banks as this can help you to get the best interest rates. You can skip all the hassle by using the free personal loan comparison tool from CompareHero.my which will help you compare and get the best deal for a personal loan.

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Fara Joifin

About Fara Joifin

Fara is a Senior Content Writer at CompareHero.my. She gets excited when she scores a good deal and has an obsession with the Northern Lights.