Bad Vs Good debts – How it can impact your financial goals

Should I invest money or pay off my debts first?

How should I determine my financial goals?

How can I get out of bad debts for good?

These types of questions are common when a person is trying to begin his investment journey. In this article, you will know the difference between good and bad debts and how you can manage bad debts to achieve your financial goals.

Before getting into the investment world, you need to first assess your current financial situation. If you have major debts, then find out how to get rid of it. 

Let’s understand what is good and bad debts

Debt financing includes principal, which you must repay to lenders, and interest. Your income will get reduced by the amount you pay back to the lenders for availing debts.

Debts exists in many shapes and sizes. Here are few examples;

  • Car Loan
  • Bike Loan
  • Education loan
  • Credit card debt
  • Personal loan
  • Home loan
  • Business loan

You can overcome any amount of debt if you have a proper plan to get rid of it.

Debts can be good or bad depending on how you use it.

Bad debts is a loan that you have taken to buy something that doesn’t put money right back to your pocket. Which means by borrowing money, you are not increasing your earning power. In simple terms, money borrowed does not produce any cash flow for you.

For instance, you have taken a huge loan to fund your honeymoon trip, whereas your monthly salary does not support the loan repayments.

We have seen many salaried individuals buying superbikes with high EMI to enjoy their ride. It’s not a bad idea to have a superbike. But, you have to make sure that the monthly EMI can easily be paid out of your source of income. With no savings if you are considering buying a superbike, then it may create problems if your source of income is blocked. Same logic applies when you have used debts to loan a car.

Good debts are those that create or enhance your earning power or help you to buy or acquire assets. Assets can be used to generate passive income or to take care of your future. For example, a home loan taken for your dream house is a good debt.

Impact of bad debts on financial goals

Most salaried individuals work to earn money, and then use that income to pay their personal expenses.

Many individuals have a habit of buying luxury cars and bikes by taking debt, whereas they have not started investing money for their future.

We are not against buying luxury cars and bikes, but you have to remember that these are all expenses for which you have taken a huge debt, whereas your investments might not be that good compared to the debt.

When you constantly pay interest for taking a huge loan compared to the assets you have, you are going backward in your hopes of building a comfortable future.

Remember, all debts and borrowings are not bad. If you have taken a debt for a house, then it’s not a bad idea to take a loan for it.

While taking major debt, you need to ask yourself how borrowing money will increase your ability to earn money in the near future or create assets.

Do not borrow money to invest in the share market, to fund Honeymoon Trip, buying luxury cars and superbikes. It will not increase your earning power, it will increase your debt with no guarantee of future gains.

If you are planning to invest in the share market by taking a loan, then please note that there is no guaranteed return from the share market in the short run. 

Some people are keeping their home as a mortgage to invest in the share market. Don’t jump into this kind of temptation to invest in stocks. If your investment goes wrong, which is quite possible in the stock market, can you afford losing your home? If not, then why take a loan against your house to invest in the stock market where there is no guaranteed return.

Remember, we are asking you to avoid taking debts to invest in the share market. It’s not that you should not invest in the stock market. You invest your own surplus money for the long term with a financially sound company to get a good return.

Credit card debts are carrying higher interest rates compared to other loans. Don’t be a victim of credit card debts when credit card agencies are calling you to use your credit card to avail loan in easy EMIs.

How to get out of debt’s suffocating hold

If you don’t have savings, with lots of debts, nothing will be left after the salary credited to your bank account. Experts call it a recipe of disaster.

You can categorise debt into two segments: good debts and bad debts. You might have understood the difference in first part of our discussion.

Having debt with less or no source of income is a big burden. It gets heavier and heavier every single day if you don’t have any source for repayment.

The best way to get rid of debt and to have financial independence, is to have multiple sources of income. If you are in a job, then try to get another source of income like making money through affiliate marketing, blogging or through any other part time job.

You can even start a YouTube channel to get some additional income to fund your requirements.

If you have  a huge debt like a home loan or multiple home loans and your income is the only source for repayment or your spouse does not have income to repay in case of your death or job loss, then we suggest you to go for insurance. In case of any issues, your debt will be repaid by insurance companies.

Goal settings is the beginning of your financial planning. It will give you meaning and direction to reach your destination. Therefore, we suggest you have a proper financial planning before getting into a debt trap. If you are already in the debt trap, then plan it to get out of it.

10 Ways to Manage Debts

There can be many ways to manage debt. It depends on your source of income and saving habits and amount of debt you have taken. 

Below we have listed few simple and easy tips to help you to manage debt;

  • Set up a financial plan
  • Have a monthly spending plan and stick to it
  • Have an emergency fund
  • Write down each purchase you make. You can use your smartphone or notebook to track your expenses
  • Pay off the highest paying debt first
  • Don’t add unnecessary debts to your personal balance sheet
  • Save and invest for your retirement
  • Cut your spending

is a fellow member of the Institute of Chartered Accountants of India. He lives in Bhubaneswar, India. He writes about personal finance, income tax, goods and services tax (GST), company law and other topics on finance. Follow him on facebook or instagram or twitter.