What's the Difference Between Good Debt and Bad Debt?

Whether a debt is ‘good’ or ‘bad’ depends on how it is used or managed. If a debt adds to your net worth or has future value, it can be considered a good debt. Bad debts occur when the contrary happens and you find yourself struggling to repay your loans. If you manage your debt well, it can reap more benefits. For example, an education loan that can be a gateway to a high-paying job or a mortgage loan that can let you achieve your goal of homeownership.

Recognising the difference between debt and liabilities that are beneficial and detrimental is vital.

In this article, we will learn more about good debt, bad debt,  examples of good debt and bad debt, and how debt consolidation can be a solution to help manage your debt better.

What is Good Debt?

Good debt is the one that enables you to fulfill your financial objectives, such as beginning a business, buying a home, or paying for education. If debt is used to build a strong credit history through timely payments and using the available credit responsibly, it may be beneficial in the long run. Debt can also be considered to be good if it offers favourable terms like low-interest rates and flexible repayment options.

Examples of Good Debt

Suppose a student takes out a loan from a bank for higher education. The interest on student loans can be tax-deductible, and the rates are generally low. Among the advantages are better career prospects, which could eventually raise their earning potential. As long as the repayment is done in a timely manner, the debt will help you build a good financial history.

Other examples of good debt can include:

• Mortgage that lets you finance your dream home
• Business loans to help you expand your operations and increase revenue
• Unsecured personal loans that do not require collateral and can be used to consolidate debt at a lower rate of interest

What is Bad Debt?

Bad debt in simple terms can mean money borrowed that cannot be repaid on time.  Repayment becomes challenging when the monthly payment exceeds the monthly income. Bad debt represents the outstanding debts of a company that are thought to be uncollectible. Loans with high-interest rates and unfavourable repayment terms can also lead to bad debt. A history of bad debt can affect the credit score negatively. 

Examples of Bad Debt

Suppose a borrower takes out a loan to purchase a two-wheeler. If the repayments are managed responsibly and on time, the borrower can build a strong credit history. However, the debt can turn bad if the borrower struggles with repayment. This will also negatively impact the credit score. 

Other examples of bad debt include:

• Short-term, high-interest payday loans that have to be typically repaid by your next payday
• High-interest credit card debts
• Loans that may not yield future income or value, such as lavish vacations

Good Debt vs Bad Debt: Quick Overview

A good debt allows you to make long-term, meaningful purchases such as business expansion or a college education, which over time can help your financial circumstances. 

A bad debt is one that does not give you long-term benefits or goes beyond your ability to make monthly payments. Unchecked credit card debt or short-tem, high-interest loans such as payday loans can be a few examples of bad debt.

How to Handle Debt Effectively?

Here are some pointers that can help you better manage your finances and debts:

• Always think of the future before making impulsive purchases. Consider long-term benefits while applying for a new loan or credit. Consider whether it will only add to your debt burden, or become an asset such as a business expansion loan that can help you generate more revenue. 
• Having an emergency fund to deal with an unexpected crisis is also a smart idea, in case you want to avoid using credit cards. 
• To keep lenders from considering you a risky borrower, try to keep your credit utilisation ratio (the amount of credit used against the available limit) below 30%. 
• Prioritise making timely repayments and make sure that you use the funds acquired through the loan responsibly.

Debt consolidation: A Possible Solution for Bad Debt Recovery

Any debt can turn good or bad depending on how you manage it. Moderation is the key when it comes to debt; even good debt can go bad if used excessively. 

If you are dealing with multiple high-interest loans, you can consider a debt consolidation loan. It is where you can take out a single loan or credit to pay off multiple debts, with a potentially lower interest rate. In addition to lowering monthly payments, debt consolidation can simplify your life as you have fewer bills and EMIs to take care of. One of the common ways is to take out a personal loan which can help you merge all your debts into a single amount. However, it is important to make sure that you plan for timely payments and address underlying spending habits to avoid adding to your debt burden after consolidation.

SMFG India Credit offers personal loans for debt consolidation at attractive interest rates starting at 13% per annum*. With an online application process that requires minimal documentation and loan disbursals within 24 hours* or 1 working day* of loan approval, you can get quick access to the funds you need.