Good Debt vs Bad Debt
You may have heard the expression “there is good debt and bad debt” and this is a very true statement but do you question what is good debt and what is bad debt? That’s something I’m answering today, helping you understand simply the importance of both and how it affects your finances and so forth.
Bad Debt
Bad debt can be derived from purchasing liabilities, things that don’t generate an income for you, won’t pay for itself down the long run. A car is a perfect example of this, you take out a loan, pay x amount of interest over 10 years and then you get hit with on road costs, services and other fees - taking money out of your pocket, not putting money in. Don’t be fooled, this can also apply to houses if you don’t do your research. Another example is a credit card, instant money people take for granted without using it properly. Unless you are levering your money using a credit card, you’re actually stacking bad debt onto it, forcing it to work against you like speeding up a timer on a bomb. In order to keep out of bad debt, you need to understand the importance of keeping out of it, making sure you’re ahead of the game, unlike many in society today.
Good Debt
Good debt is utterly important as it opens the doors of passive income to you if done properly. Before banks lend money out to a customer they assess the persons financial status. For example, how much they earn per year, what assets do they own, other sources of income and their credit history. If this strict criteria is met, then it’s a green light to lend and this would be classified as good debt. However, if the bank lent money out to someone who couldn’t afford the repayments on time, had no financial history or income, then they are taking a high risk and it becomes bad debt, much more risk involved.
In order to generate a passive income, you need to purchase assets that will automatically make money for you, however not everyone is born with a million dollars so how do you ‘afford’ these assets? You need to borrow money, leverage it and manage it effectively. Let’s say you found a house, the house was $50,000 and you only had $30,000, you would need to borrow the extra $20,000 to purchase it. Before you do, you need to consider if this will generate more income then the expenditure. So if your loan repayments was $300/week and you were renting it for $400/week, you are making $100/week in passive income, allowing you to pay off the loan much quicker. However, if the house wasn’t paying itself off by its own income, then it would be classified as a liability, something that is taking money out of your pocket and putting it into the banks. There can be exceptions, different investments require different levels of money however, research and planning is critical, making sure your projected income is rock solid.
The more money you put into the house, the faster it gets paid off, the less interest and more profit. This allows you to invest into more ventures by using the equity in the house. This of course applies to all investments and there will always be risk, the idea is to minimise it as much as possible.
The above has been based on knowledge I have learnt from experienced and knowledgeable people such as my Dad and Robert Kiyosaki. Please remember I’m not a financial advisor nor do I ask you to follow my advice, if this ever proves useful, please share it as we all should live in abundance.
No responses yet
