Debt’s multifaceted nature allows it to empower, disable and enable depending on the circumstances surrounding its use. Individuals, corporations, institutions and governments all make use of debt for varying means and goals. These means and goals of debt usage are evident in monetary history and contemporary practices and reflect the double-edged nature of the practice of lending. This article will illustrate the concepts of ‘good’ and ‘bad’ debt in terms of its usage, requirements and practices over time.
THE TWO NATURES OF DEBT:
Historically, before debt laws allowed financial amnesty to overburdened debt holders, debtors unable to pay their debts were enslaved. (www.ihatedebt.com) Fortunately, these practices became outlawed allowing judicial assessment of debt obligations and restructuring. Naturally, if one finds oneself in this type of situation, the debt has become a heavy financial burden and is more likely to be ‘bad’ debt.
Contrarily, if debt is used in such a manner as to allow one to become wealthier, more able and achieve more with one’s life, such debt may be dubbed ‘good debt’. Moreover, ‘good debt’ may take the form of a loan that allows a person or business to accomplish more in terms of better meeting service, production, and skill objectives. Generally, good debt facilitates rather than debilitates development. Good and Bad debt may be distinguished as follows:
‘Good Debt’ :
* Low interest rate
* Helps achieve a goal
* Contributes to productive personal choices
* Is not spent on lavish amenities
* Improves rather the worsens credit rating
* Is affordable
* High interest rate
* Many fees
* Serves no useful purpose
* Is unaffordable
* Supports a bad habit i.e. shopping, addictions etc.
* Leads to financial distress
TYPES OF ‘GOOD’ AND ‘BAD’ DEBT:
Debt has many forms and comes from different sources. The many types of debt can also serve to differentiate between good and bad debt. For example, ‘bad debt’ may arise out of unscrupulous lending practices that do not adequately take into account the use of the debt, and how it will be repaid whereas good debt may have either more flexible lending terms and/or take into account the ability of the borrower to pay back such debt. Some types of debt are illustrated below and are then defined in terms of ‘good’ and ‘bad’ debt.
* Household services ex. Utilities
* Business, student and automobile loans
* Property mortgages
* Individual and Business Credit cards
* Personal loans
* Government loans
The above types of debt may be either good or bad depending on the circumstances surrounding the debt. For example, the same property mortgage may be unaffordable for person X, but affordable for person Y. In the latter case the debt may be good in the sense that it is practical, and leads to potential equity savings whereas in the former instance, the mortgage might produce financial hardship, and be out of reach financially. In other words, debt that is good may also be bad depending on who is receiving the debt.
Debt is a historical financial instrument that has been in use since ancient times. Over the course of history, debt laws, debt structure and the evolution of financial markets has led to increasingly sophisticated types of debt in addition to a range of debt risks. Debt risks can be stemmed and limited through debt lending practices such as the loan application procedure and through laws governing the use of debt.
Understanding the difference between good and bad debt may vary on a case-by-case instance as each borrowers intention, fiscal discipline, business plan etc is different. Debtors attempt to limit and prevent good debt from becoming bad debt through the loan application procedure, and credit screening. This process however, is not immutable and requires lenders and borrowers alike to discern whether debt will be good or bad for them based on past financial patterns, financial forecasts, debt terms and agreements.