Difference Between Good Debts & Bad Debts | How To Avoid Bad Debts

Well, I will start saying that there are three types of people in India when it comes to debt handling.  

  • One, will try to get rid of debt as soon as possible
  • Second, will pay current debt and take a new debt to buy some fantastic things
  • Third, the financially literate people.

Well, I don’t want to offend anyone by calling illiterate and that’s not the topic as well, but the problem is, many people in India really don’t know the difference between two types of debts. Actually, taking a loan is considered as bad and one takes loan only when he/she left with no choice except taking a loan.

So in this article, I’ll try to explain about two types of debts/loans (good & bad) and how one can take a good loan and avoid bad loans. So let’s start with good loans.

Good debt

Not all the debts are bad, good debt exist too. Actually, debts which helps to increase your income or net worth can be considered as good debts. Mainly three types debts fall into “good debts” category which are, education loanbusiness loan and home loan. There’s a one notable thing is that good debts can also turn into bad debts if not paid on times.

  • Education loan: Its an easy concept. The better educated person is, the greater possibility to find a well paying job. The one who got a good job can start paying the loan. But before taking an education loan, make sure that the degree you’re gonna hold has career opportunities. Else it will turn into a bad debt too.
  • Business loan: There’s an old saying about money.
    It takes money to make money
    Taking a loan for business is normal practice which business owners do either for business expansion or when the business is new. Settling a self sustainable business is not easy. But if you successfully establish a good business, it will create wealth for you. But business is all about taking the risk, risk of failure! It CAN happen too. So while plan your business I suggest to follow this quote.
    Hope for the best, prepare for the worst.
  • Home loan: Having own home is a dream for many and taking loans for home is considered as ok. Also, some wealthy people invest in real estate property for rental income and gain some capital on selling that property. Home loan is one of the safest loan in India.

Bad Debts

Taking unnecessary loans to buy fantastic things is the worst mistake one can do in his/her 20’s. One who fall in debt trap once, don’t take loan again.

  • Personal loans: I know people take personal loan when needed only, but personal loan comes with high interest rates like 17-18% which is too much. To avoid personal loan, one should create an emergency fund for himself/herself.
  • Credit card: Pure bad loans! Credit card comes with beautiful reward systems when you pay using that, but once you failed to pay at the time, there will be some random percentage interest rates, which will definitely be high plus there will be lots of calls and messages from credit card company.
  • Unplanned loans: even if you take the lower interest rate loan but unplanned loans may become unwanted loans. Taking a loan is also a part of financial planning and one don’t plan anything about financial decisions, might end up with no saving and loans.

How to avoid bad debts/loans

Avoiding bad loans is easy and hard at the same time. You just need to follow four points I’ve written down below.

  • Stop unnecessary spending: for some time, you need to stop buying unnecessary things and eating unhealthy and costly food. I will ask you to save some money and create an emergency fund for yourself. Once you have successfully created it, you can start living your older life style. But with an emergency fund, you will not need to run for a personal loan when you need money.
  • Stop buying things you can’t afford: look, if your salary is 10-30k per month then you simply can’t afford an iPhone. You can check yourself that what you can afford and what you can’t and when you want to buy a thing which you can’t afford then ask yourself, “Is it necessary? “
  • Write down your monthly spending: you will think like “what it has to do with loans?” but I will tell you why and how it’s important. Once you write your monthly spending, then you will find some unnecessary, unneeded and unwanted spending which you will just regret when you write. Then it’s simple, don’t spend next time where you find it unnecessary. And save that money, which help you to avoid taking a loan.
  • Do financial planning: that’s the most important thing one should do. One must have plan for spending & saving decisions. I might sound repetitive, but trust me, it’s one most useful concept to apply and it gives you the control on your money. This concept is not for only to ‘avoid taking bad loan’ but it’s far more helpful.

At the end of this post, I will like clarify that some loans don’t fall into the good or bad category. These loans are Car loan and consumer durable items loans etc.