What is good and bad debt
Good Debt, Bad Debt - What's the Difference?
The word “debt” alone inevitably leads to a bad feeling that each of us would love to avoid.
But not all debts are the same; as is so often the case, it depends on the context in which the debt arose.
So what is a good debt or a bad debt?
Bad debt is consumer debt. Consumer goods such as smartphones and cars lose their original value very quickly.
The loss in value is particularly rapid with new cars. In the first year the value drops by approx. 25% and in the third year the value has already dropped to 50%. Now imagine you buy a new car on an installment loan. The car costs you € 20,000 and you pay it off at just under € 417 per month over four years. Without a deposit, of course.
It takes four years until you have repaid the installment loan. Now your new car has become a used car and has already lost over 50% of its value. Or put in numbers, you took out $ 20,000 in debt to buy a car, which is now worth $ 10,000. Of course, it is also assumed here that you can easily repay the installment every month and not be in default.
By now it should be clear what bad debts are. A simple phrase to use to identify bad debt is: "Will this cost me more money in the long run than it can bring me?"
Are Cars Basically Bad Debt Now? In most cases, yes. The exception would be if you buy a car with the intention of renting it out permanently. If you end up taking in more than you spent, it is no longer a bad fault per se.
Tip: When buying a car, leave out the ego. Do you really need a new car? Or is a four year old car enough? Although this continues to lose value every year, you have already saved yourself the worst loss in value, so to speak.
After so many negative things about debt, now is the time to say positive things about it.
What are good debts now?
Good debt is essentially debt for capital goods that will make you more money in the long run than you paid for it and that increase in value. A classic example of this would be real estate.
For example, you are now buying a property, but you can only make 10% payments because you don't have more capital available. So you take out a loan from your bank to buy the property. Now you probably have a loan that runs for around 20 years, so you pay off your loan at your bank every month. What is the difference to the above now?
Bad Debt Example?
Quite simply, you rent out the property at the same time at a rental price that is higher than the monthly loan rate you pay to your bank. Now your tenant is basically paying the loan that you took out and you have made an investment that will bring you money in the long term and even increase in value.
Because if you bought your property in an area that is becoming increasingly popular, it will even increase in value and at the same time the rental price will rise.
Expressed in numbers: The property has a price of € 120,000, you finance the property with a loan from your bank and pay off the loan over 20 years in monthly installments of € 500 each. However, you rent the property to your tenant for € 600 per month. So you have 100 € and your landlord pays off your entire loan, as already mentioned above.
So after 20 years you have earned € 24,000 and at the same time have a property worth € 120,000, which in the best case can even be a lot higher.
It all sounds very good, doesn't it? Of course, that's just an example on paper. Even with the best of intentions to grow your money and make good investments, you can fall flat on your face. This can result in renovation costs for a property and it can also be that your property is empty in between if you have not found a new tenant in time.
In the worst case, it could also be that your property loses value over the years and nobody wants to move to the area where you bought it. Another possibility would be that you bought the property at the height of a boom and the value of your property is now going steeply downhill.
So you see there is no guarantee of success here either, but you shouldn't let that slow you down! Making mistakes is part of it, after all, and after all, you wanted to get into good debt and invest.
By now it should be clear what good debts are. A simple phrase to use to identify good debt is: "Will this make me more money and will I have more of it in the long run?"
Can a smartphone be an investment?
As mentioned above in the text, it always depends on the context in which the debt arises. So if you buy a smartphone and intend to use it for business purposes and earn money directly or indirectly from it, it can be an investment.
E.g. can you build a reach on social media with a smartphone and earn money with sponsors? Another option would be to make business calls and get in touch with prospects for a product or service.
Good debts are debt for investments that can bring you long-term money and increase in value.
Bad debts are debts for consumer goods that do not bring you any money in the long term and also cannot increase in value.
Even if you intend to make an investment and run into good debt for it, it can backfire. Example: You buy a property at the height of a real estate bubble. The bubble bursts and all of a sudden it is only a fraction of its original value.
Now that you have learned a lot about good debt and bad debt, you can also roughly assess what good debt is and what bad debt is.
So start identifying good debts and bad debts in your life now, get rid of bad debts and avoid them in the future too, and start getting more good debts!
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