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Nobody likes to borrow money from someone else, but we all have or will face a situation in life where we will need some extra cash.
While borrowing from a friend or family member has less profound consequences on your creditworthiness, there can be a difference with the type of debt you owe a financial institution.
When a bank checks your credit history to see what kinds of debts you have, they will look at some debts more favorably than others. Not all debts are equal!
If you are working your way to pay off your debt, it would do you good to first understand the difference between a good debt and a bad debt.
Debt is considered to be ‘good’ if it is a sensible investment in your financial future or helps you to buy wealth-building assets.
There is a clear and specific reason for taking up the loan and a realistic repayment schedule, and should ideally help you generate an income over time.
Here are some examples of a ‘positive’ debt:
Taking a student loan to pay for further education will help you in the long run as you typically get paid more in your future employment.
A home loan is perhaps one of the biggest loans you take on in your life time and it can be daunting to have to repay so much money.
However, buying your own property can also be one of your greatest asset purchases in your life.
You can earn from rental property while still servicing your debt, or earn capital gains as property assets are likely to grow in value over time.
While this may not be considered good debt, borrowing money to start or expand a business is generally seen as a good idea, especially if business is booming.
Being a business owner means you may have to borrow capital to hire new employees, buy new equipment, manufacture your new invention or invest in marketing.
It helps to have a goal in mind with a realistic business projection so that your vision does not crumble in a pile of debt.
Bad debts are those that are unnecessary and unsustainable. It is used to buy items that you do not need and often fall in value, or it carries huge financial charges and incur high interest rates which make repayment difficult.
Here are some examples of things you should think seriously about getting into debt for:
Credit Card Debt
According to the Credit Bureau of Singapore, about one in five credit cardholders has been rolling his debt for three months.
Credit card debt piles up faster than you realise and is often used to pay for things that you buy on impulse rather than need.
To avoid credit card debt, make sure to pay off the bill in full each month!
I strongly recommend that you set up Giro deduction to ensure you don’t miss any credit card payments. When used correctly, credit cards can even save you money by giving you discounts, cashback or other rewards.
Whatever the reason for taking a personal loan, you should think twice due to its high interest payments. Be it a loan from a bank or a licensed-moneylender, borrowing at high interest rates is just not worth it.
Examine why you need that money in the first place, and whether there are ways to mitigate the urgency of the loan with advanced budgeting or setting up a regular savings account.
Seek help with credit counseling if there is a particular problem.
Cars are often considered a liability more than an asset as its value decreases over time. Other than paying for the cost of car, there are hidden costs such as maintenance, road taxes, petrol and car insurance to take care of.
Public transport is easily available in Singapore compared to bigger countries, so make use of it unless you are certain you can afford the luxury of owning a private car!
Related Article: Household debt and what it means