What's The Difference Between Good Debt And Bad Debt?

The term ‘debt’ is mostly associated with negativity. However, like many things in life, there’s always a good side.

While some loans are usually detrimental to your financial standing from the get go (such as overspending on shopping and travelling expenses, etc.) there is another end of the spectrum with ‘good’ loans that actually add value, likened to the old adage "it takes money to make money."

However, even the best of debts with the initial intention of growing wealth might quickly turn into bad debts - it all really depends on where you draw the line. Read on to learn more about good debts, and how they can turn into nasty ones if you’re not careful.

What is a good debt?

Good debts: Making sure it’s really ‘good’

So here’s the concept of good debts: If the loan will help increase your net worth or generate more income, it’s GOOD. However, things will never be as simple as it seems, so let’s dive in deeper with a list of debts identified as ‘good’ - as well as the slippery slopes you should take note of:

Higher education

It is no secret that with more education, a person’s future income will be more likely improved and secured. To maximize the ‘good’ value of this particular debt, one should weigh the pros and cons in degrees of interest. If there's a lack of demand for your degree of choice, this good debt can quickly turn into a BAD one.

For example, it was found that Actuarial Science students are highly sought after, with an average starting pay of $60,000. On the flip side, Fine Arts degree students face an unemployment rate of 12% and earns an average starting pay of $30,000.

Unsure which degree to go for? You can always start by picking the right pre-university programme to explore the options.

SME ownership

This is literally making money with money. As compared to education loans, this is riskier and might turn bad as well. Therefore it is important to start with a business that is an area of your expertise, driven by passion.

It’s also important to do thorough research about funding that business idea of yours.

Real estate

Between 2016 and 2017, there’s an average growth of 2 real estate billionaires EVERY week. Therefore, it’s not a surprise that many people are rushing into real estate investment.

However, if you’re a novice investor without the skills or knowledge, taking a loan for this purpose might turn into a bad debt quickly. Therefore it’s imperative that you know the basic tenets of property investment:

Last Resort: Ask for help

Regardless, it’s always easier said than done, especially when it comes to money matters. Therefore, if you ever find yourself going down that slippery slope of debts, always seek for help!

You can do so in two ways:

Contact your loan provider/bank immediately for negotiations. Most of them are willing to negotiate terms that will allow you to repay the loan reasonably.
Contact Bank Negara Malaysia’s Agensi Kaunselling dan Pengurusan Kredit (AKPK), which is the Credit Counselling and Debt Management Agency. They offer FREE counselling and will assist you with debt problems personally. More info on AKPK here.

If you need more help determining which loan suits you best, here’s a tool developed by CompareHero.my that compares loans and interest rates from numerous banks:

What is a bad debt?

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

Buying items that depreciate over time, such as a car
Unpaid credit card debts
High-interest loans

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.

Relate: What Happens If You Make Late Credit Card Payments

How to pay off debts

Even if it’s good debts, they’re supposed to be paid off. What’s the smartest way to pay off debts?

The ‘snowball’ method: Researchers at Harvard Business Review discovered this method to be the most effective strategy in paying off debts.

Quoting the researchers, “Focusing on paying down the account with the smallest balance tends to have the most powerful effect on people’s sense of progress — and therefore their motivation to continue paying down their debts.”

Key takeaway

At the end of the day, it takes good judgement and proper planning to prevent good debts from becoming bad ones. And the same also applies to paying off debts on your plate. Be smart about it, make it work for you!

Before taking up a loan, compare loans from banks as this can help you to get the best interest rates. You can skip most of the hassle using the tools like the free personal loan comparison tool from CompareHero.my.

Know The Difference Between Good Debt and Bad Debt

CompareHero.my Team