good and bad debt manage effectively

The Difference Between Good and Bad Debt, and How to Manage Debt Effectively

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Debt may not sound like a very attractive word. In the beginning, people googled naive questions, “How many bank accounts should I have” and then why debts are dangerous. 

And there are reasonable explanations for this: the risks of non-payment, it can negatively impact your credit score, can limit your ability to save for emergencies, invest in your future, can cause stress and anxiety, and of course, you may be at risk of bankruptcy. 

But don’t let its reputation lead you astray. Yes, the risks are obvious, but on the other hand, sometimes, only debt can help you achieve your goal. But some types of debt are better than others. 

What Is Good Debt?

Good debt is a type of debt where you borrow money to invest in something that you think has the potential to help you become wealthy or achieve your financial goals in the future. It also helps you raise your credit score. 

Now there will be some examples of good debt, but remember, even good credit can become bad if you take on more than you can pay back or at too high an interest rate. 

• Student loans: taking a student loan means investing in your future income. Of course, a bachelor’s or master’s degree may not be an asset like a house, but by investing in education, you get such benefits as a high salary. 

• Commercial mortgages: Since the cost of housing increases yearly, this type of investment is considered a reasonable option. Owners can also rent out the house all the time, which will bring them passive income. 

• Business loans: if you borrow money from the bank to cover, for example, equipment or workspace, it is considered good debt if it leads to increased profits and financial stability over time.

What Is Bad Debt?

Bad debt is a type of loan where you take out something that doesn’t have the potential to increase in value and won’t bring you any income in the future. Bad debt is typically used to cover people’s current living expenses, as well as for purchases that will depreciate over time. If this thing will not increase in value or will not bring you income, then you should not go into debt to buy it. This includes: 

• Cars: it is considered a worthless investment if you have taken a car that is much more expensive than you can afford or if that car depreciates very quickly.

• Credit card debt: it is considered a bad debt because they are often used to finance purchases that are not necessary. They also accumulate interest charges quickly if not paid off in full each month. 

• Clothes and consumables: everyone has situations when they want to buy beautiful clothes or furniture and all kinds of other things, but borrowing to buy something using a high-interest credit card is not a good idea. 

The Difference Between God and Bad Debt

The main difference between good and bad debt is that good debt is used to invest in something that has the potential to increase in value or generate income over time. In contrast, bad debt is used to finance purchases or expenses that do not have the potential to increase in value or generate income. There are several more differences we should talk about: 

• Cost: Good debt often carries lower interest rates because the borrowed funds are used for investments that are considered less risky. While bad debt often has higher interest rates.

• Potential benefits: Good debt tends to pay off over time as the value increases. Bad debt, in turn, can lead to stress, financial strain, and eventually bankruptcy. 

• Impact on credit score: Good debt can positively affect your credit score, as it shows you are responsible for dealing with debt and investing in the future. Bad debt can have a negative impact on your credit score, especially if you default on debt and don’t make payments on time.

Micro Lending Market 

Microlending, also known as microcredit, refers to the practice of providing small loans and other financial services to individuals or small businesses who do not have access to traditional banking services. 

The goal of microlending is to provide individuals and small businesses with the financial resources they need to start or expand their businesses, improve their livelihoods, and lift themselves out of poverty. 

The global microlending market size was valued at USD 29.39 billion in 2021 and is expected to expand at a compound annual growth rate (CAGR) of 13.4% from 2022 to 2030. The industry’s growth can be attributed to the growing adoption of microfinancing. 

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For instance, according to the 2019 report of Microfinance Barometer, almost 140 million borrowers are micro-financed by microfinance institutions worldwide, with an estimated total loan portfolio of USD 124 billion. 

How to Manage Debt?

Step 1: The first thing you should do is make a list of all your debts, including their interest rates, your monthly income, and what percentage of your salary you are willing to give each month to pay off the debt.

Step 2: Request your credit report. This will help you understand if you have any debts and if all your previous debts have been paid off. You can also ask the bank for your credit score to check its current status and whether they can give you another loan.

Step 3: You should look for consolidation opportunities. If you have several loans with a high-interest rate, you can combine them into one with a lower interest rate. This is all done individually for each case, so you should contact a consultant at your bank. 

Step 4: if you think your debt is overwhelming, it’s worth looking at your monthly spending. Perhaps somewhere you can save money, and this extra money will just go to pay off your loan. 

Step 5: The last thing you should do is determine the strategy you will use. There are two most popular — Debt Avalanche and Debt Snowball. First, you will pay off the debt with the highest interest rate, and second, with the lowest interest rate. Which strategy to choose is up to you. In any case, you are on the right path, stick with your plan, and you will succeed.

The Bottom Line 

It’s important to carefully consider the purpose, cost, potential benefits, and impact on your credit score of any debt before taking it on. Not all debt is the same. The main thing to understand is the main difference between good and bad debt. And decide for yourself what is right for you in your situation.