Saturday, February 28, 2009

Good debt and bad debt. Can you make the difference?

A debt is generally a sum of money that you borrow from a lender to buy something that you don't have enough money to buy now. In the past people used to borrow only in exceptional cases. Like buying a house, a surgery or any emergency. However today people borrow all the time to satisfy even the flimsiest of urges.

So how to control your debt?

There are two types of debt:

1. Good debt

Debt that you take that would truly benefit you. Like a mortgage, a loan to buy a car, a student loan or a loan to start a business. Such a loan will give you benefits in the future and would increase your financial security.

2. Bad debt

Bad debt is any debt that you could do without. Most if not all of the time it is just a fancy, to be trendy or to do as someone else is doing. Such debt will make your financial future insecure and will make your life miserable over the long run. They are debt to buy furnoture, clothing, vacations, etc.

It is important to avoid borrowing to buy things that you cannot afford or that you ca go without. As such the environment that you are evolving is important. It is better to stop meeting people who are living way above their means as it would influence you over time. Live around frugal minded people and discuss ways of reducing spending with them.

The next important thing is to limit the part of your income that go towards servicing debt. While some people can be it i not always possible. So keep the percentage of your earnings that goes towards paying debt as low as possible. Around 30 % is about right. Remember that increase in interest rate ca increase that percentage and make servicing those debt unbearable.So keeping that percentage as low as possible would benefit you both in high and low interest rate times.

Avoiding debt is just one of the way to be financially secure. If you add hard work, frugality, saving, investing, etc with it then your wealth will increase with time.

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