In most cases debt is considered to be bad debt since it impacts negatively on your net worth. Although there are a few scenarios where debt is considered to be good debt.
You need debt to obtain a credit rating especially when you are young and need to buy your first home or car. It is however critical to manage your debt well to maintain a good credit rating. When you miss payments or pay short of the amount you owe, you will quickly build up a bad credit record which can impact negatively on you for years to come.
Interest free debt could be considered as good debt, for example a clothing account offering a 6-month interest free payment plan. You postpone paying for something upfront and can earn interest on the cash in your bank account while repaying your account over a period. This is the ideal solution to start building a good credit record if you manage it well.
When using debt to buy an asset of which the value increases over time can certainly be to your benefit. That is why your home loan is considered to be good debt – it usually has a lower interest rate than other forms of debt. You are also paying off your own investment.
Debt can be useful and considered to be good in scenarios where you are ultimately creating wealth. Using debt to buy a second property of which the rental income will cover your instalment or part thereof, is a good option. In this scenario somebody else is paying your bond on your behalf and thus creating wealth for you. The same applies for when you are using debt to buy or expand a business from which the projected cash flows will cover the bond and create additional income and wealth over the longer run.
Business owners can also consider negotiating with their suppliers to repay them over time as opposed to on a cash basis. This can definitely benefit your cash flow especially if you can manage to negotiate the deal without paying interest. In this scenario your suppliers are funding your business at no cost to you. Creditors should however be well controlled and your budget should allow for it.
In the right scenario debt can benefit you, but you need to manage it carefully and you need to make sure you use it to create wealth. Avoid using debt to buy luxury items or to pay for your living expenses.
Written by Ronel Jooste
CA(SA), Financial Consultant and Coach, Blogger and Speaker
Contact Ronel: firstname.lastname@example.org