Understanding Debt – Its Necessity or Luxury; and Consequences (Part 1 of 2)

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Understanding Debt – Its Necessity or Luxury; and Consequences (Part 1 of 2)

Debt is basically the amount of money borrowed by one party from another. It could be between people or companies, or a mixture of both. It is created primarily by the difference between income and expense; regardless of its nature and purpose.  Understanding debt is one of the key fundamentals that can liberate people out of unnecessary financial bondage. It is high time people understand debt and its implications on their future and livelihoods.

1. Good Debt:

Good debt is an investment that will grow in value or generate long-term income. This category includes mortgages, business loans, study loans etc. The most important aspect here, particularly on business loans, is to do a cost-benefit analysis. Your expected return on investment should be enough to cover the loan interest charges, and still remain with some profit to cushion the business as a going concern. For instance; you may borrow a business loan of $1000 at 10% interest per annum. Upon investing in your business, you will realise profit before interest of $200 for the same loan period.  Therefore, given that the loan interest is $100 (i.e. 10% of $1000); therefore the net profit after interest charges will be $100 (i.e. $200 less $100). If your loan interest is higher than the return on investment, then it is not a good debt at all. Your business will not be sustainable, hence the going concern will be compromised.

2. Bad Debt:

Bad debt is debt that is incurred to purchase things that quickly lose their value and do not generate long-term income. These include consumables such as clothing on account, car loans, furniture, appliances, luxury items, flashy lifestyle, store credit cards, holiday loan and restaurant meals; to mention but a few. The fundamental factor underlying bad debt is that it does not generate return on investment. It is just incurred for consumptive purposes. Therefore, for one to repay it back they have to rely on another source of income which is not related to the debt itself. In most cases, these types of debts are repaid through debit orders into one’s salaries account. Consequently, reduced income at home might mean one’s children dropping out of school, family being thrown out of their lodgings, medical cover being cut-off; and many other negatives that may arise due to reduced family income.

Whether it is good debt or bad debt, debt must be managed properly! People get into various levels of debt as a result of many reasons. And while circumstances differ; but in general, you are encouraged to avoid debt at all costs. Debt carries with it a heavy burden of managing it. It is my fervent prayer that you live a debt-free life!

The article continues in Part 2.

Tapiwa Zuze

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