Debt is the Big scary D word that keep many awake at night.
In fact an average citizen is over $38,000 in debt!
According to cnbc the number is not including home mortgages, and the trend is on the raising!
More than 53% of the working class stress over debt according to PWC.
But should you be worrying?
If you are like me, most parents tells us that Debt are bad, and we should keep ourselves away from debt.
Debt is the monster that keeps us awake at night. And if we are not careful, we will be in deep financial trouble.
Is Debt all that Bad?
Is there debt which is good? Yes!
Not all debt is bad!
A good debt can helps you secure your financial future.
In fact, this is the debt where the rich build their riches and wealth.
Like a secret society, this form of debt is less known to commoners like us. Thus the rich get richer and poor get poorer.
But things is going to change, and you can be a part of the change.
Do you want to learn about this form of debt?
Lets dive in!
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Difference of Good VS Bad Debt?
Simple rule of thumb:
- A good debt benefits your financial future by increasing your net worth or has a future value.
- A bad debt harms your financial future by decreasing your net worth or has no future value.
These simple difference creates the rich and the poor and a bad debt can become worst when you don’t have enough cash to pay which make you having negative net worth.
What you are buying with your resources often makes that distinction clear.
Here we will further explain on the different Good Debts and Bad Debts you may want to have or avoid like a plague.
Read ‘Rich Dad Poor Dad’ by Robert T. Kiyosaki. Robert T. Kiyosaki is a self-made multi-millionaire which in his #1 best seller book shares his story of two dads: his father, the ‘poor dad,’ and his mentor, the ‘rich dad’. A easy to digest read for beginners and to learn about debt.
- Check out Rich Dad Poor Dad’ by Robert T. Kiyosaki
If you want to get very rich and wealthy. Start your own business. You have much better chances to becoming wealthy by starting your own business than being an employee.
An employee fulfill the dreams of others, a business owner let others help them fulfill their dreams.
But this doesn’t mean to ask you to quit your 9-5 job today and start a business. You can always start a side hustle. A side business can give you both the benefits of having the security of a steady paycheck with your job and the money potential of a business.
You can check out our post on passive income later and read about it as well. But for now lets focus on business loans.
These loans are usually called Small Business Loans that is designed to help startup get their first funding.
But the risk involved to the borrower defaulting the loan are higher. These loans are tougher to get and may required a sound business plan to be presented to the lender.
As illustrated in my other article on Traits of Successful Startup, only one-forth will survive the first 5 years in business.
With a little luck and not fearing the hard work, borrowing money to start your own business could be the best investment you’ll ever make.
Mortgages are also generally viewed as a source of good debt. But this form of debt is currently debatable. When too much of a mortgage loan, it will be very bad for your finance, but when it strikes a balance. Mortgage loans are good form of debt.
According to Robert Kiyosaki author of the Rich Dad Poor Dad, your house you live in are generally not your asset but is an liabilities as they take money from you. But if you buy a house and rent it out, it is an asset as it bring you money day-in-day-out.
People such as Grand Cardone author of The 10X Rule build a portfolio of over 4,000 apartments using mortgage loans. And in his latest Book, How To Create Wealth Investing In Real Estate showed us how to do it!
With the same concept, when you buy a house and got an mortgage loan. Your monthly payment to your house is to build equity, instead of just going to a landlord.
Always remember the difference of needs and wants in mind. Do not over stretch your finance by borrowing too much for your mortgage.
An affordable low interest mortgage loan to buy your house can be a good debt.
You can simply find out how much do you need to pay for your monthly loan with a simple Mortgage Calculator.
Owning a house instead of renting one can be benefital to you in both mentally and financially.
Being a home owner will also reduce your stress level and improve your quality of life.
You may be very familiar with this kind of loan. In fact, almost everyone who went to colleges are quite familiar with student loan.
You may have finished paying your student loan, or you are still paying your student loan.
The numbers may be pretty huge. Because some schools and courses is much more expensive than other.
On average student who borrowed to study owns $35,051 when they graduated as according to cnbc.com.
That is a lot of money! How can this be a a Good Debt?
A student loans allow you to get an education which increase your long-term earnings potential. Investing in yourself helps you to become more competitive in the society, so you may increase your chance to get promoted.
A big fatter paycheck is probably something you may want for the rest of your life.
If you have a degree, you will most probably earn 66% more than those who don’t, as reported by wgu.edu.
I think it is a pretty good trade off, don’t you guess so?
But you will always want to prioritize your loan payment and aim to pay it off as fast as possible.
The interest rate can be quite high. You may not want the interest rate to eat into your fat monthly paycheck right?
We guess so too!
You can checkout our other article to learn how to plan your debt payment with a Simple Guide to Get Out of Debt Fast!
You will definitely enjoy that article, I promise. But first, lets continue to explore good and bad debt.
If you want to change your life and be in control. Self-development is one of the best investment on yourself and reading is the cheapest and easiest way to do so. Check out some of the Best Books you should read to help develop yourself into a even better self.
What is Bad Debt?
Bad Debt is the form of debt that average people have which decrease our net worth. This is the type of debt that make the poor become poorer.
Bad debt is the reason why most average people find it hard to become rich.
Bad debt is the kind of debt you want to avoid at all cost!
If you want to become rich, you will have to set a budget on your expenses.
The worst and most viscous debt of all bad debt, the poster child of all bad debt is none other than payday loans.
These are the little monsters that can grow into the king of all monsters in the matter of months. Usually small dollar amount of less than $500. These loans are designed to be due at your next payday.
With a fees of over $10 to $30 per $100 borrowed, payable per month.
It can be calculated into an annual percentage rate (APR) of over 404% to 1,378%.
Which means, if you borrower $100 today and pay your lender 12 months later at a rate of $15 per $100 borrowed. You will have to pay $404.56 in 12 months time, with $304.56 as interest. If the interest is $30 per $100 borrowed it will calculated to over $1,378.58 in 12 months time.
To put it into perspective, Warren Buffett the legend of Value investing have an annual return of approx. 28% for the last few decades. This rate of return have made him $85.8 Billion and the one of the richest man on Earth according to Forbes.
Payday loan are basically legal loan sharks that is there to take your money in broad daylight!
Coming to the second place, we have Credit Cards. These little pieces of plastic can ruin your financial health. These can be really bad debts depending on how you uses them.
Have you ever been confused with how the interest rate is calculated or the idea of the minimum payment?
Figuring how the credit card works can be really confusing. And this is exactly what these financial institutes want! Ever wonder why financial institutes earn big bucks?
Because you are paying them!
And if you have forgotten to pay your credit card bills on time, good luck pal. Because you will be in for a surprise for your next bill.
Remember that brand new 60-inch high definition smart TV you brought last week?
Say you got really lucky and found one on sale for just $2,999, and you put on your Credit Card with the 19.9% interest rate over a 36 month payment plan.
You will be paying $111.30 per month for the next 36 month. At the end of 36 month you will have paid $4,006.80.
That is $1,007.80 in interest, enough for you to pay for a round trip to Hawaii. I think that is a really expensive way to watch Jennifer Lawrence or Brat Pett in high resolution don’t you think?
The average credit card debt per household in the United States is $16,883! And average number of credit card per person have is 3.1.
These are some stunning and scary statistics.
Credit card debt, especially when taken on for unnecessary purchases such as chasing the latest version of iPhone, or getting branded good that you couldn’t afford is undoubtedly bad debt.
This is more of a grey area, as you may need a car to get to work or sent your kids to school.
But do you need to drive a Mercedes Benz G-Class to achieve that? Or do you just need a Toyota C-HT?
The type of car you choose to buy can make an auto loan a necessary debt, or a very bad debt.
A debt for a need and a debt for a want is different.
- Need: Is something you required for your daily life
- Want: Is something that is good to have
New cars depreciate as soon as you swipe your credit card for your purchase. A new care on average decrease in value by 10% on the first day and a total of 15 to 25% in the first year as reported by finders.com.
Which means you will be 10% poorer the first day you buy your brand new Mercedes Benz G-Class.
So, when you are buying your first car. Always check if that is what you need and not what you wants.
Paying interest of auto loans for years on an purchase that fall in value every single day is harmful for your financial future.
You can always choose well maintained used vehicles. The decline in value for a second hand car will be much less than as their new counterparts.
Risk of Debt
Debts have an inherent risk, as you’ll need to fulfil the debt obligation which usually comes with an additional interest rate.
When we take on good debt. We are making assumption that the future is good and typical with the results of the past. But in this world there is no guarantees.
A business loan doesn’t guarantees business success.
A college degree doesn’t guarantee a great job after graduation.
A mortgage loan more than you can afford can be a disaster in the making.
Furthermore, the stress from getting too much debt can lead to mild to severe health problems.
Nonetheless, debt when being used well, it does have an upside potential.
Therefore, before taking on any debt, it is always advisable to carefully consider your ability to service the debt.
What to know before taking up debt?
Know your credit
You should know your credit score if you are deciding to apply for a loan.
Most credit score falls between 350 to 850 and most lenders (banks and financial institute) will check for your credit score before determining your defaulting risk.
Any credit score with over 720 is consider excellent with a low defaulting risk.
Any credit score below 500 is consider poor with a higher defaulting risk.
People with high credit score will have the benefit of getting a loan at a lower interest rate, while low credit score will usually mean higher interest rate with lesser banks willing to approve your loan.
Some factors that affect your credit score are:
- Payment history.
- Availability of balance.
- Number of open accounts.
- Number of loans.
All rates are not equal
The cost of getting a loan differs between banks and financial institutes.
If you are considering to getting a loan for your house, to study, or even for investment, it is always worthwhile to shop around for cheaper rates.
Loan with a lower interest rate of even just 1 percent can result in hundred of dollars in savings.
Prepare your documents
If you are applying for a loan, it is important for you to prepare all your necessary documents. The list of documents requires are usually listed in the website of the bank.
Commonly required documents
- Past 12 months pay slip
- Bank statement
- Notice of employment
- Photocopy of your ID
Most loan providers will check for your past 60 days bank balance before giving you a loan.
Questions to ask before taking up debt
- What return do you expect to get and what if you don’t?
- How are you going to pay the debt, and can you afford it?
- How do you expect life to look after taking on this debt, what if things don’t go as planned?
These are just some question to guide you before you decide to take up the debt.
Because all debt have to be paid someday.
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Should you have debt?
Good debt can help you when you use it wisely.
Bad debt will always ruin you if you are not careful.
It is your responsibility to be conscious of the type of debt you are taking. Debt are basically future money which you have to return one day.
But the right amount of good debt can increase your wealth and help you secure your financial future. Learning about the good debt is only the first step to success and riches.
Your discipline to follow your goals and stay away from the bad debts that make the rich wealthy.
Are you up to the challenge avoid bad debts and learn about how to use the good debt wisely?
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Disclaimer: I am not your financial adviser or lawyer, information found in our website are just my opinions. You should always ask your financial adviser or lawyer for any financial or law related advice.