While good debt holds the potential to increase your net worth, bad debt achieves the polar opposite. A debt is labelled as ‘bad debt’ is the money borrowed is used to take ownership of depreciating assets. So what are depreciating assets?
Depreciation is primarily an accounting method which allocates the cost of assets over it’s useful life or life expectancy. Depreciation therefore represents how much of that asset’s value has been utlised already.
In other words, if a particular asset is not going up in value or generating an income you should avoid going into debt for the same. Although having an understanding of good debt is really important I argue that understanding bad debt is more important primarily because of how prevalent financial failings are and how they affect the human brain to create stress. However, I digress. Moving on to the concept of bad debt, here’s some notable assets which lead to creating of bad debt.
- Cars: This might come off as confusing for some because the utility of a car varies from one person to another. Cars can be considered as useful assets for those who need it to say get themselves to work and to run errands as are essential for daily functioning. However, objectively speaking paying an interest on this commodity has no returns. New cars lose their value faster than any other asset the moment it leaves the showroom. It is always a better financial decision to opt for a used car.
Granted, older cars usually turn up with issues regarding reliability which might end up costing you more later. However, if your due dilligence is proper you will be able to find an automobile for a cheap price and with demonstrated reliability.
- Clothes, Consumables, and FMCG Products: Clothes are notoriously overpriced and racking up debt for purchasing high brand clothing is just poor financial choicemaking at its worst. In a surprising twist of facts vacations, fast food, groceries, and fuel are some of the most commonly bought items with borrowed money. It obviously has zero ROI and the debt money is better used elsewhere.
- Credit Cards: These are without a doubt the worst form of debt primarily because of the high interest rates. Apart from that, credit cards are like drug dealers to addicted victims. A notoriously large multitude of individuals use credit cards to pay for a lifestyle they cannot ordinarily afford and thus end up in a vicious cycle of debt which they cannot seemingly get out of. Credit cards which provide points per spending when used with caution can turn a profit for the user.
With all that being said, it is imperative for us to understand that debt is something which can break us or make us. One must always take steps to ensure they are within the good graces of good debt that allows them to increase their wealth and keep on growing financially while avoiding sinkholes that achieve the opposite.