Debt is a kind of liability that takes money from your pocket. In today’s time, we generally take loans to complete our desires or necessities. Desires like buy a car, washing machine, jewelry, mobile phone, or other electronic products. What poor and middle class does; they just purchase these products on loan EMI’s.
95 out of 100 people I know who buy a mobile phone on loan EMI. Loan EMI is doing nothing just take money from your pocket with interest. These kinds of people who buy products on EMI become assets to the banks. These people earn only for the banks. They entered the bad DEBT TRAP.
This is what most of the poor and middle-class people do. I have seen so many peoples who are dealing with their bad times due to this only. Due to that, we all be afraid of the debt. Those people’s financial illiteracy leads them to deal the bad situations. There are different scenarios as well. It has been conditioned that all debt is bad, but it does not true. Most people view it as a four-letter word. We have been taught to fear debt. But there are good as well. Rich peoples used it to build their wealth just because of their financial knowledge.
DIFFERENCE BETWEEN GOOD AND BAD DEBT
There is a clear difference between good and bad if you understand it well.
Bad debt is that you pay for out for your pocket.
Like loan EMI of your mobile, loan pay-out for your car. They are taking money every month from your pocket.
Good Debt is that someone else pays for you.
To grow a business, a businessperson takes it from the bank. This is good if it is paid out with a positive cash flow of the business.
To better understand the difference between the two requires an understanding of Assets and Liabilities. Like an asset is something that puts money in your pocket the same is good debt. Whereas liability is something that takes money from your pocket, the same is bad debt.
Let me explain you with an example.
Suppose you purchase a car as your personal vehicle on loan EMI. It is a liability because it is taking money from your pocket.
The same car if you used as a business (like Ola, UBER) as a part of making money where the income would cover the cost of a vehicle, it would be an asset because it would put money in your pocket each month.
Now, look debt behind both the cases, you can see the difference between the two. In one case; it is in service to liability while in another case it allowing to obtain an asset.
THE BAD RISK
Bad Debt is always dangerous because it builds a false belief of affordability in our minds. It creates a definition that,
“If you can pay loan EMI, it means you can afford”.
But, the correct definition of affordability is,
“if you have enough savings to purchase, you can afford it”.
This is the thing that the poor and the middle-class peoples forget it. Due to this false affordability, the increased debt on them and become slaves to their jobs. Eventually depended upon their paycheck life and entered the DEBT TRAP.
THE GOOD PROSPECT
Good debt allows you to manage your finances efficiently and provide leverage to build your wealth quickly.
Education Loans – Education loans allow you to get an education and increase your long-term earning skills. Taking loans to get educated is a good debt always.
Small Business Loans – If you take loans to start your own business it falls into a category of good debt. Because loan allows you to start or grow your company to increase cash flow. In India, there is an MSME sector where they allow you to take loans, but you must create some comprehensive business plan for approval.
THE BOTTOM LINES
Whatever it is good or bad there are always risk involved in it. But we must understand the actual financials behind the Good and the Bad scenario.
If we understand the proper use of debt than we can use the leverage to grow quickly. It only requires little extra knowledge of financials.