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Good debt VS Bad debt - Is there a difference?

good debt vs bad debt is there really a differnce

In this article we will be discussing Good debt VS Bad debt in a different fashion.

So lets break some myths to start out this article and say that not all debts are bad.

There actually is good debt and bad debt. 

Ok now that the big word “debt” is out in the open, let’s discuss a bit what this means and how understanding this concept can help you change your life to better.

If nothing else lets hope it at least gives you a better understanding on how to use debt to your advantage.

At some point in our lives we all have been in debt either for money or some favor to somebody helping us out in a moment of trouble.

When you loaned a favor or money from someone, it meant you were the one in debt and you knew the debtor will come to collect as some point (especially with money related debts).

Contrary if you made a favor to someone or loaned money, you were the debtor and generally you set a debt repayment date or increments.

Then again, if it was a family member, you likely just wrote it off as with family the lent money alot of times means money given away 🙂

Alright then, lets dive in and discuss both good debt vs bad debt and why there is a very important difference between them.

Use the table of contents below or in the sidebar, to navigate through sections of the article:

Table of Contents

Lets start with "What is Bad debt"

what is bad debt

If someone stopped you on the street and asked you:

What is Bad debt?

What would you answer?

I bet plenty of people would say “Any debt is bad”.

I know my mother would say so for sure and plenty of other relatives too.

Then some people would maybe mention a car debt, a mortgage for the house, a wedding expense loan or simply borrowing money from the bank in general.

Why do I say the Bank?

Because some people like to borrow from friends and acquaintances and never return the money, so that is not really debt for them 😛

God forbid you should ever make your self indebted with shady people…

NOW THAT IS REALLY BAD DEBT

…or simply bad judgment.

What is really the definition of Bad debt

In general most people think that any debt is bad and can not really differentiate.

So for those of you who haven’t heard this before, let me put it in plane terms for you to understand “What is bad debt?“:

“BAD DEBT IS ANY DEBT THAT TAKES MORE MONEY FROM YOUR POCKET THEN IT HELPS YOU EARN BACK”

Now imprint those words in your mind as we will dive in to clear your doubts about them or enlighten you about them.

To do that, let’s list some type of bad debts and explain why I consider them such.

List of Bad debts which you should avoid

Well, the title is a bit misleading in the context saying “that you should avoid”.

You probably should still avoid them if you aren’t someone financially stable, but I realize that sometimes you still might have to take them because…

…well, life is a complicated thing.

Ok let’s list those bad boys…I mean…bad debts:

  • Let’s start with Car debt or loan for buying a car 
  • Taking a loan for a vacation is considered bad debt too
  • Your own living house mortgage loan is essentially a bad debt, but read the paragraph where I explain my thoughts
  • Even a student loan for me is considered bad debt

After reading those, what is the most common denominator in these loans?

It is the fact that you get to enjoy what the money buys now and you get to pay for it later.

That is what they call consumer’s debt.

It is everyday’s people like you and me that need something now and are willing to pay for it later with an interest.

Why do I say that is a bad debt?

…when plenty of times you need that car or house mortgage or that shiny jewelery or that vaction so bad?

To be honest in some of those instances the loan can actually even be a good reasoning, but more on that matter when I explain what is a good debt.

The main reason why I say those are bad debts, it’s because people just float away their hard earned money on these “pleasures”.

Let’s give some more concrete reasonings why those debts are bad:

Car debt, why is it bad debt?

Now, there are instances when you need a car for the new job you just got and the frigin workplace is 1h away with bus, but 20 min with a car.

In this instance if you don’t have much money, taking a loan for a car is not the worst idea, but you should still be weary and not buy something expensive thinking:

“No worries, I got it on loan, I can repay those monthly rates easily”

If that is your thinking, then you are making a bad investment and therefore a bad debt.

Why do I say so?

It’s because a cheaper car will do the same work for you and get you from point A to point B, but you wanted to have those fancy extra gadgets that the more expensive one has.

Don’t get me wrong, if you have plenty of money and you earned it, you should definitelly pamper yourself to enjoy your hard work.

But if you are strugling and buying the car mainly for a job purpose, then you should limit yourself and go for a cheap car instead.

Ok, the one above is a good example and I hope you are writting this down…in your mind, because now I want to expose the real bad reasoning for buying a car on a loan.

And this is what I really call a bad debt.

Buying a fancy sports car "just because you can"

So for those of you who maybe got a new fancy job who might be thinking:

“A new sports car would be nice and hey, I can take a loan for it.” 

Well, if you are one of those people, you are thinking about a bad debt, because there is a good chance you can not afford it otherwise.

When you make that decision, what you are doing is getting instantly gratified by being able to use your new fancy toy.

That is good, right?

No, it actually isn’t…

Who are you to tell me that I shouldn’t buy a new car for my efforts at the new job?

I am not honestly.

What I am trying to make you understand is that by doing so, you are basically putting a rope around your neck.

Why do you say so, I can now enjoy my new car and feel good in it…?

Yes, but while you enjoy your car now if things change and you lose your job, what will happen with the car?

There is a good chance you will struggle for a while trying to repay it, then probably will have to sell it or have it be taken from you if the car was bought on Leasing.

While doing so, you will likely be loosing more money doing an effortless effort in order to keep it.

At the end of the day, you will be left with no car and no money to show for the good work you did while being at that fancy work place.

Is that something that motivates you?

Because acting this way, you are basically eating away your future, by denying yourself the opportunity to make the money work for you and not the other way around.

This example perfectly illustrates an outcome that many face and will face when they go and take a loan for a fancy car when in reality their financial stability is still in question.

Instead of thinkg of how to buy a new car, you should be thinking to get a loan to start a new business or invest your money into something yielding you more money back each month instead of taking it away from you.

Conclusion…Bad debt.

Let’s move onto vacations now.

Taking a loan for a vacation and more reasoning why people use it as a bad debt and how you shouldn't

Here is another good example of how some people use their loans to make themselves bad debt.

Now all of these situations I am mentioning with loans aren’t necessarily bad, it’s just that people are using them in a wrong manner which I will demonstrate later with some “simple math” to solidify my reasoning.

Vacation loans are in my opinion again bad debts, as in the example above with the fancy car, you actually get instant gratification by loaning a big/ish amount of money in order to get some pleasure right away.

Most people simply ignore the fact that they will continue paying for the loan  for some time after the vacation is over.

My reasoning with debt and loans in general is, to take a loan on something that you could otherwise afford as well, but prefer paying off in rates as it keeps your cash flow better so you can use your money for business or investment still, while repaying that debt.

When you take a loan for 1-2k for a vacation, it might still be too much if your base paycheck is low, but I suppose is somewhat acceptable.

But there is people who like to go big and take a loan for few thousand dollars for a mega safari or cruise ship vacation, which sure, will likely be unforgetable…

…but mainly because you will have to pay for it for a long time after it’s over, so you will have something to remind you of it.

….god forbit something went wrong on the actual vacation, you will probably resent yourself spending that money for a very long time as well.

At the end of the day, or in this case the vacation, you will go back to work and work your arse out in order to pay for the extravaganza you allowed yourself, even though your financials are bad and you shouodn’t have done it.

I know we feel some time the need for a good vacation to get back in the right shape.

Yet you should always be looking to calculate how this will affect your financial future and therefore your life in the long term before making such a move.

Which I suggest you should do with most things you do in life.

Therefore Bad debt.

House mortgage as a bad debt

Well as much as many might hate me for saying this or even resent me, your own living in it house mortgage essentially is a bad debt.

Why do I say so?

Honestly, these words don’t come from my own garden of thoughts, but is something I learned reading the book series of “Rich dad, Poor dad” from Robert Kyosaky.

In those books the author demonstrates with math how these are “bad investments” or bad debts.

This particular specific is something I learend from the book “4 quadrants of Cash flow”.

As mentioned above, many of you who actually took a loan for buying your own home will hate hearing, is that this is a bad debt from an investment point of view.

You can call it a bad investment or a bad debt, either works.

So why does the author and me call buying your own home a bad investment?

Well, it’s for the simple fact that you are actually loosing money on it until the house is repaid in full.

But lets see a comparison of renting and buying a home, to give you a better picture.

Renting or buying your home - the comparison

buy or rent
Should you buy or rent? It depends...

Many are probably thinking, but buying your home is better then paying for the rent as you are actually paying for something that will eventually be your own.

And that I agree upon to some degree…

Why don’t I agree fully?

It’s because of math….

and stress that it brings if you are unable to pay the monthly rates…

for one reason or another.

To put examples more in perspective, there is also the fact that when you are looking to buy a house either by loan or by cash, you will be looking for a real nice place and not some shit hole, since you are planning to live there for longer…

…or the rest of your life for some.

What does that mean?

It means that your mortgage repayment rate is going to likely cost you more per month then if you are monthly renting an appartment.

Why again?

It’s because when we are renting, even if we always want a good place for our rent money, we won’t always find one such.

In these cases we will still be willing to take a cheaper place, which will likely not be as accomodating.

But that way we save some money on rent, therefore potentially pay less for renting then for the mortgage loan rate on a monthly basis.

Why are you putting so much emphasis on the monthly expenses?

Well, it’s becuase human culture and the way we currently live mostly evolves on monthly cycles, therefore my math is based on those.

If you can keep those monthly cycles in check and have a good cash flow, then you will do good in life…

…at least financially 🙂

Having said all of that, I hope I am painting a good picture about how most of us look at things and why renting VS buying is not so black and white.

Before we move on, I want to give another strong case why in some instances renting might actually be better.

It's all about the cash flow!

what is positive cashflow and negative cash flow
Click on the image for a quick reference to what is cashflow

Cash flow is that magic word that brings all of this together.

Even though this is a subject for an article of it’s own, I want to mention it here in this context to paint a better picture and make it easier to understand things.

As mentioned above, humans mostly live in monthly cycles as for most the paychecks come on a monthly basis, same goes for our expenses like, gas, electricity, mortgages and so on…

…and there is also the food and other things we calculate in depending on the needs.

So what does that mean in practice?

Well, in practice for the context of buying or renting it depends which is cheaper and which allows you to have a better cash flow overall…

Having a good cash flow means to have more money coming in then going out.

If renting an appartment for a lower monthly fee then your mortgage would cost you monthly, that is a definition of a better cash flow…

BUT

It’s not always quite like that.

It also depends on your bigger financial plan and what you are doing with the rest of your money that you save if you are renting cheap.

Cash flow math example for renting or buying your home

Lets use simple numbers for the sake of not complicating and lets say your monthly income is 1k dollars.

In reality everything demonstrated in this example is likely 1,5 or 2X the amounts shown, so keep in mind this is for easier math’s sake.

Example 1 home mortgage repayment:

In this example let’s say you buy a house or an appartment by taking a loan at the bank.

It’s a nice house because you took your time to find something nice that will be worth your money and taking that loan at the bank.

If you decided to buy a random house which isn’t what you wanted in the first place, then you likely wasted your money and put yourself in an even worse situation then the one I will describe.

So for the sake of this example your repayment monthly rate for the house is 500$ for the next 20years which is:

20x12x500 =120.000$ + bank’s interest  around 2,2%, other fees we will not calculate in for this example and the need to have a downpayment of about 3-5% at least.

For more in dept calculations and information how to figure your monthly repayment rates, please visit this website.

They use a nice interactive system to help you determine your repayments…

To continue on the example above, now you have 500$ to pay each month for the house loan.

Your other expenses like food and other “life utilities” cost you another 400$ a month if you are a very conservative and savy person (of which gas, phone electricity and other utilites are calculated in), what you are left with is 100$ that you can spend for some extravaganza monthly or to save or invest.

Now investing that money on a very long term can still net you something, but the math is highly against getting any life changing returns in a near future.

On the other hand, using or saving those 100$ for a vacation or some luxury item, still doesn’t net ya much of anything.

So you see, what you are here is stuck for the next 20 years with a big debt and very little cash to use after your life necessities are covered.

You can’t even take another loan to start a business to make more money, because you have a house mortgage already and you are liable for that, so no bank will give you another loan likely.

Your options here are limited, unless you get a new job or some other income stream somehow.

…which inheritantly makes your loan a bad debt.

Example 2 renting an appartment:

As bad as it may sound to pay a rent for living, and it’s as they say “just money down the drain”, there are merits to it.

But let me explain what I mean.

First of all if you rent, you are likely paying it out of your paycheck or other sources of income, so you don’t have a debt because of it.

As for the money down the drain part, as long as you are concious and trying to get to financial independence somehow, you likely will not be spending lavishly and renting an appartment you can barely afford.

If you are smart and I think you are, else you woudln’t be reading this article 😉 , there is a good chance compared to the case above, you will be spending around half or maybe 60% of the money you would spend on a house loan…

…because if it’s not your own home, you can afford to live in a conservative and humble housing for a greater good.

For math’s sake, let’s assume you spend around 300$ for your rent and rest of the expenses are similar to above, so let’s say 400$ monthly.

On your paycheck of 1k, that means you are left with 300$ compared to 100$ from 1st example, therefore more wiggle room on what to do with the money.

Another important factor is, that you don’t have a debt yet.

What that means is that banks will still be willing to give you a loan for starting a business or invest in whatever you please.

How much you can get again depens on your credit score and individual country laws, but for most people that means they are elegible.

To put more salt on the wound, by not commiting to a housing debt, you can still move to another place if the place you are currently renting isn’t really great…

…where with the house bought by loan, you still need to find a buyer and go through everything that comes attached to selling a house.

That stuff can get very complicated….

…and also expensive some times.

Have a few acquaintances myself, that can testify to that fact too.

Short conclusion about house loan being a bad debt

In these few examples I hope I illustrated my point, which I believe many of you were somewhat aware already.

If you weren’t…

You are welcome!

Having a loan on a house is not always bad, which I will demonstrate later on, but in the illustrated case it is.

Why?

Because it makes you a 20 years slave to your house…before it gets paid off!!

There are better ways to go about which you can find out on this blog.

If you are unsure about which articles, browse them out or ask in the comments below and I will point you in the right direction.

Lets continue by analyzing student loans.

Student loans and why I think they are a bad debt

Let me start by saying that student loans aren’t all bad debt.

But if you are pursuing a career that will not allow you to earn alot of money after finishing school, then you likely are on the bad side of debt.

And I think unfortunatelly that goes for the majority of people studying and taking those loans.

On the other hand, if you are able to use that student loan to start a business or flip that money somehow, then I consider you to be on the good side of debt.

Having said that, if you are going to venture into that direction, the risk is on you.

You are the one responsible to do your due diligence before risking your own money.

So please don’t say after you do your things poorly that a guy on the internet told you to do so.

Whatever you decide to do in your life as a personal free will choice, whatever happens after, it’s all on you.

You made the choice, you bear the consequences…remember that clearly!

It’s a hard lesson and the reason why is hard, is because those who learned it by personal experience, lets just say that, it wasn’t easy on them.

But to continue on the student loan discussion.

After finishing the school where most people take it easy, enjoy parties, etc and spend a few 10k$ until graduating are then stuck with a debt they need to repay.

If we compare this, it’s like in the examples above with the luxury car or that unnecessary extravagant vacation, where you reap the rewards now an pay the consequences after.

After finishing school, you become stuck with a source that monthly eats a part of your income or paycheck away just as a welcome gift into the world of adulthood.

Oh…and btw, first you need to find a job, so more hardship on those who have a tough time with that or are hard to hire.

So you see now, unless you use that student loan money smartly and or graduate on a well paid profession, you have bought yourself a ticket to misery with that student loan and will have to pay the price for it for some time in your adult life.

Therefore bad debt.

Conclusion about bad debt

Those listed in this section of the article are just some of the examples, there are more for sure, but hopefully those illustrate enough of an idea to make you think.

If they don’t, go read them again or ask in the comments below.

What I tried to convey here, is that debt unless used in a smart manner, it’s considered bad, therefore the title Bad debt.

Debts you make that just make you pull money from your pocket are considered bad debts.

Knowing how to use debt to your advantage is a skill and debt used in a smart way is smart debt or Good debt as the main title states.

So what comes next?

The title says Good debt VS Bad debt, so it’s time to explain what good debt means.

What is Good debt and does it really exist?

good debt vs bad debt - what is good debt

Well, of course it does, it’s just that not everybody understands the concept of a good debt.

As explained in the previous paragraphs, there is bad debt and the reason why it’s called bad debt it’s because it is taking money away from you.

So what is the main advantage of Good debt VS Bad debt?

What makes Good debt good?

For those of you who are only on your first finacial steps, this may come as a surprise, but debt is not an entity of good or evil.

Debt is an idea and isn’t neither good or bad, it’s just a question of how it’s used.

The real reason that makes Good debt be good, is that when you take a debt is for the reasons of growing your financials, make more money and not the other way around.

You take a loan or a good debt in order to help you earn more money either passively or by actively working on a business of some sort.

A DEBT IS CONSIDERED TO BE A GOOD DEBT, WHEN IT HELPS YOU EARN MORE MONEY THEN IT ACTUALLY TAKES AWAY FROM YOU

To make things clearer, lets see some practical examples:

Examples of Good debt

  • Using a loan to buy a house or appartment to rent out or resell is considered Good debt
  • Taking a business loan where your business makes money is also Good debt
  • Investing money into passive income streams is Good debt in my book

In the examples above I listed a couple of Good debt options amongst which you will notice I also mention buying a house or an apartment.

Some may now wonder “how can I say that when I was just saying earlier that that is consdered bad debt”?

The answer is simple actually, but also not simple.

So let me explain what I mean by that.

Good debt VS Bad debt when buying property

This example explains how buying a house or an appartment by taking a loan can be good debt and bad debt, depending on what you are doing with it.

So earlier we explained how buying your own home and taking a loan is a bad think.

The reasoning there was that the house loan you took made you lose money each month and additionally it made you unable to take any additional loans at the bank since your monthly income statement is very negative.

Now contrary to that option, if you choose to take a loan for a house or property in order to make it better and resell it or even rent it out, the story changes completly!

Why so?

Well, lets explore both cases.

Case 1 - Take a loan to buy and resell a property

If you took the loan for a house that you intend to renovate and resell, your main idea is to make money out of the deal. 

So if you took a loan for 120K to buy a property for 100K for example and used the additional 20K to renovate it.

Reselling it later on for 160k would likely net you somewhere from 30-40k in that deal.

Why not the exact 40k?

Well it’s because there is the banks interest that gets added onto the loan repayment rates so 120k + whatever the bank adds on.

In that case, it kinda depends how soon you renovate and resell the house on how much profit you will end up with.

After reselling the house, you repay the loan to the bank and you have nice profits and are again ready to take another loan for some other business endavour if you wish to do so.

At the end of the day, a smart way to use a loan or in other words Good debt.

Case 2 - Take a loan on a property to then rent for income

So this time you take a loan to buy a property and you choose a property where you know the renting out of the property will net you more money then the bank monthly repayment rate costs you.

Lets say you choose a house for 120K and you have approximately a 500$ monthly repayment rate.

Then ideally you should be looking to buy a property that will net you monthly at least 500$ from renting.

Ideally you should be looking to gain at least double that money on a monthly basis.

If that is the case, your loan is no longer costing you money, but making you money.

You still have to pay for the loan, but now the house you bought and the debt you have was used in a smart way so it becomes a Good debt.

…because the house, now your asset, is paying for the loan by itself.

It’s not literally itself.

You still need to find the tenants, so choose a good location when you decide to buy, but you get the point I suppose…

Conclusion on debts for property buying

The 2 examples about Good debt when buying property demonstrate a simple but crucial thing.

Taking a loan or making yourself indebted when the reason for taking the debt is helping you earn money is what is called a good debt.

From the 2 examples above, the first one is honestly the better one, as it leaves you financially exposed for a lesser time, but overall both are still good examples of how to have Good debt and use that in your favor to get financially ahead.

Taking a loan to start a business - good debt?

I left a question mark on the title intentionally.

It’s beacuse I wanted to make clear that even though I believe taking a business loan is considered a good debt, you should still make your due diligence about the business you are venturing into.

You should do so in order to make sure that the debt actually ends up being good and not bad instead.

Taking a loan for a business capital is smart as long as you have a good plan an know what you are doing.

If you don’t, you might still be able to pull it off if you are persistent and a diligent worker, but I believe is better to have a good head start if you can…

…instead of playing catch up.

The whole business idea can be as simple as buying a random product for a price and resell it for a higher price.

Knowing your market and specifically if there is one, will probably make you be profittable enough to justify your loan, but as said…

the more you know about the business you are venturing into, the higher likely you can classify your loan taking as a good debt.

Taking a loan for an investment, is that also a good debt?

There is plenty of people that will tell you that this is considered Bad debt or bad investment advice.

And to a degree I will agree with those people.

If you are someone who is really bad with money management, I also suggest you to not venture into such ventures as you may do yourself more harm then good.

Instead if you are someone like me, who has had their share of bad experiences and learned from them, maybe you will understand better what I am about to say here on forward.

As a disclaimer, I am not selling this as an investment advice, instead I am simply stating what I did myself after doing my due diligence.

Similarly to the example above with real estate and housing, if you are taking a loan for an investment, you need to educate yourself, period.

This type of debt if you know what you are doing, can be your salvation, your hail marry, your reason to go from rags to riches, but you need to play it smart.

Generally speaking, taking a loan at the bank on a longer repayment period, can make the repayment rates relativey low.

If you are able to identify some good ideas or investments that will net you more money then your repyment rate costs you, it means you have found your jackpot and this can be called a good debt.

For some good tips, you can lean on these 2 articles of mine:

The 2 articles speak of various things with alot of details, but there is a table of contents if you don’t have the time or interest to read them through…

…although, I believe they are a good read.

Both of the articles mention an option of a 32-42% yearly return rate by staking your money.

If that is something that pushes your buttons, you definitelly should check them out.

Also as a fast reasoning, most banks interest rates are not nearly as high as those returns are and using that vehicle or something along those lines that you can find on your own, can help you not only have a good debt, but also retire early because of the profits accrued.

Conclusion about Good debt VS Bad debt

In this again long article we learned about what is Good VS what is Bad debt.

So what are the take aways?

For me personally I would say that those listed as examples of bad debts are essentially bad only for those without money or financial knowledge.

What that means in practice is…

If you have little to no money and you go take the bad kind of debts listed in this article, they will only make you poorer and you will never be able to get to financial freedom.

Where using the good debts as an unprivileged person, they can actually help you boost your finances and get higher on the economic hierarchy.

Another important take away which perhapse wasn’t explicitly explained in the article, but it makes sense is….

For those who have money, even the bad debts can or are actually good if they are smart about it.

Why?

Because paying for a luxury car 100k$ in cash or by monthly rates of 1,5-2k$ per month the 2nd is an obvious choice.

Again, why is it so?

It’s because if you are someone who has that amount of cash, it’s better to use ti for investment and make your investment dividends pay the car monthly rates, then paying the car directly in cash.

It’s “simple” economic math…why pay for something yourself, if you can make your money work and buy it for you.

I hope this all makes sense.

If it doesn’t re read things again or ask in the comments below.

Also if you liked the article, don’t forget to subscribe, like and share it on your favorit social media.

Cheers, 

and may the good debt be with you all.

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