In this day and age, debt plays an increasing crucial role in our lives.
Whilst some people struggle to meet monthly credit card payments, others use debt to build assets and prosper. So in fact, there are both good and bad debts in this contemporary world. In order to distinguish whether a debt is good or bad, it is important for us to understand the nature of the debt.
Good debts refer to those debts which bring about positive financial situations.
By using the debt for investment, and assuming that investment is appreciating in value, then we can in fact add to overall financial health. The most common example of good debt is a home purchase, the mortgage loan can be regarded as an investment as the home value is usually increasing at a great rate than the interest on the loan.
On the contrary, the debts that are not applied to an asset that appreciates in value, but rather bring unhealthy and negative financial situations would be regarded as bad debts.
Credit card debt is usually an example of bad debt. Since the items that credit cards are normally used to purchase are “consumed”, accumulation of credit card debts would normally imply unhealthy financial situations. Common examples of this type of consumption debt include the purchase everyday items such as a television or the finance of a vacation that we are not able to afford.
Many clients seek our advice regarding bad debt. In the financial planning stage, we should always schedule to pay off the bad debts first, since they provide no value, and hence they are a drain on financial health.
Many clients seek to use what would normally be good debt, such as a home mortgage, to payoff bad debt. This is not a good idea since repaying bad debt with good debt is in effect reducing the effectiveness of the good debt. In fact some people end up on a continuous cycle of refinancing their home loan to pay off this bad debt, and in effect never catch up because they live beyond their means.
Is it time you reviewed your debt situation? Why not set up a meeting with us now for some hard hitting advice on your debt issues.