The difference between Good and Bad debt

by Dale Petersen and studio@brandesign.co.za | September 11, 2023

Good debt
The words good debt and bad debt are often used, but what do they mean? This article will provide an understanding of the nuanced differences between them and how they impact our financial lives.

It is worth noting that debt can be utilised in a manner that could enhance or propel an individual or business toward financial growth and success or steer them to financial instability or regression. Here, we’ll clarify the differences between these two concepts and provide you with an understanding and framework to distinguish between the two to help you make informed financial decisions.

Merriam Webster describes debt as: a state of being under obligation to pay or repay someone or something in return for something received: a state of owing. In financial terms it is described as a sum of money that is owed or due.

Good debt:

Can be described as any form of credit that enhances or benefits your life. Often, this type of debt is taken or utilized to create wealth.
Characteristics of good debt:

  1. Good debt should contribute to your or your companies’ financial growth.
  2. It must enable investment, that in the long term should exceed the cost of repaying the loan.
  3. It should enhance your life or business and should provide a sustainable, long-term benefit.
  4. It is important to understand that good debt also typically comes with better or more favourable interest rates, this allows for a lower overall repayment amount and a lesser monthly instalment.

Examples of this are:

  • Home loans or mortgages: Property often appreciates in value over time. This is a prime example of good debt because as you service the debt, the asset gains value.
  • Student loans: Student loans should be utilised to gain an education, thereby increasing your earnings potential and setting you on a favourable long-term path.
  • Business loans: Entrepreneurial endeavours often require capital. These loans are used to expand or grow a company. Borrowing to invest in a business can generate returns that exceed the loans interest.
  • Investment loans: When you borrow money to invest in income generating assets, this could be in the form of shares or property.

Bad debt:

Bad debt often comes with very high interest rates, this makes it incredibly hard to settle or pay off. Unlike a house or building that generally appreciates in value, forms of bad debt will not increase value over time or add to your wealth. This kind of debt puts more pressure on you and rarely provides any long-term benefit.
Characteristics of bad debt:

  1. High interest rates.
  2. Depreciation in asset values.
  3. Impedes your budgeting due to high instalments.

Accumulating bad debt over time can have a compounding negative effect on your financial position. As interest continually accrues, it becomes increasingly difficult to escape the negative debt cycle.
Examples of this are:
Loans with high interest rates applied to it, payday loans, loan shark deals or credit cards that have high fees applied to them.

  • Loans with high interest rates applied to it, payday loans, loan shark deals or credit cards that have high fees applied to them.
  • Credit card debt: specifically, when used to purchase non-essential items.
  • Personal loans: When accompanied by high interest rates that negatively impact your financial well-being.
  • Retail store accounts.
It is worth noting that while good debt can pave the way for financial growth and prosperity, bad debt can lead to a cycle of indebtedness and stress. It is therefore crucial to understand the benefits and risks of each debt type and it is pivotal to make the correct decision for you or your business. It is critical for all individuals and businesses to understand their risk appetite at any given stage and utilize debt appropriately. When financial opportunities arise, it is vital that good debt is leveraged in order to maximize the opportunity while minimizing the risk.

Remember, careful consideration and the strategic use of debt is the key to financial well-being.

For more information, Contact Dale Petersen on 021 819 7802 or at dpetersen@wauko.com. We’d love to connect with you.

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