When you look at your monthly bills, you may feel overwhelmed by the amount of money that you’re spending on repaying debt. When a lender looks at your credit report to see what kinds of debts you have, they will look at some debts more favourably than others. Not all debts are considered equal! Sometimes debt might seem like a burden that you only want to fight your way out of, but not all debt is necessarily bad.
A good debt is one that is a sensible investment in your financial future and should leave you better off in the long-term. You should have a clear and specific reason for taking up the loan and a realistic plan for repaying it promptly in a series of regular payments.
Some of your debt might be considered an investment so if you took on the debt to purchase something that will appreciate in value and can contribute to your overall financial health, then it’s very possible that debt is a good one.
Here are some examples of what makes a good debt:
Student loan. Taking out a study loan to pay for higher education will help you in the long run as it should help to increase your value in your career.
A mortgage can be a good debt, because it will enable you to purchase a property which is considered an asset. Once that mortgage is paid off, that home will be a big financial asset, which is likely to grow in value over time and the monthly mortgage payments could be cheaper than rent.
However, do note that this could be a bad debt if you overestimate how much you are able to pay and went ahead to purchase a property that is more expensive that what you can pay for. A good ratio to remember is that your housing expenses should not take up more than 30 percent of your month salary.
Investing in your own business. A loan to help you develop your own business can also be a good debt, as long as you have a sensible and realistic business plan.
Ideally, your total monthly long-term debt payments, including your mortgage and credit cards, should not exceed 35 percent of your gross monthly income.
Bad debts are those that drain your wealth, are not affordable and offer no real prospect of increasing in value in the future. Bad debts can also be defined by having no realistic repayment plans, or simply borrowing to buy what you cannot afford.
If you can’t afford to borrow the money (you struggle to make the monthly repayments) it is almost certain it is a bad debt.
Here are some examples of things you should think seriously about getting into debt for:
1. A luxury watch you can’t afford. Having a luxury watch could be the dream of your life and a great motivation for work, but buying it on debt is a definite no-no. Anything material which is not absolutely necessary and requires you to borrow to buy is almost certainly a bad idea. If it is not a need, it should only be bought when you have excess cash to spend on.
2. A car you don’t absolutely need. If you don’t need to buy a car, think twice about it. Cars are often considered a liability more than an asset as its value decreases over time. Public transport is easily accessible in Singapore so we should make use of it unless we are certain we can afford the luxury or owning a private car.
3. Borrowing money to pay bills. If you are struggling to even pay your utility bills, you may need to re-look your spending habits. If you find that there is a particular problem, do not be afraid to seek help with credit counselling.