Understanding Debt – Its Necessity or Luxury; and Consequences (Part 1 of 2) Debt is basically the amount of money borrowed by one party...
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.
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