Good debts have been defined by most accounting textbook as debts that can be recovered. Bad debts is defined as debts that can not be recovered. While, this definition is on a business level. But, when it comes to personal finance bad debts and good debts have a different meaning.
Well, this may be supprising to you or may you may already know about this. But knowing what they are can enable you understand what kind of debts you should owe and the types you should throw out of the window.
I read an article in ezine.com on this. It says that bad debts is any debt that accrues interest every month on outstanding balances but whose value reduces with time while good debts are debts that also accrued interest but their value increases.
The term value distinguishes between good debts and bad debts. Good debts increases in value while bad debts diminishes in value.
Examples of good debts are mortgage loans, education loan, and probably a car loan since car will give you a level of value in terms of convenient but it can also be classified as a bad debt since the money value decrease with time. Examples of bad debts on the other hand are buying consumables on credit, borrowing money for parties that will not add any value, and borrowing to buy a gadget like phone. Please note that it is not wrong to buy any items by borrowing, however caution need to be taken.
WHAT TO DO?
Now that you know the difference between a good debt and a bad one. What should you do?
(1) Reduce Bad debt.
You will need to reduce taken loan for items that do not add value to you. If you already owe to many bad debts try reduce it by paying off your bad debts as soon as possible so that you can focus on good debts.
(2) Embrace good debt.
You can focus more on good debts such as getting a mortgage loan to buy or build your dream home. You can also, use such loan to build a house for resale. Houses appreciate in value. This means that you can sell of the house and make capital gains.
(3) Use money you want to spend on bad debts for retirement plan.
Instead of borrowing for bad debts that you will end up paying interest on. Use your money wisely and apply for a retirement saving plan. There are so many pension companies, while not take advantage of them. You are never to early to start saving for the period that you will be an old person.