Positive Debt & Negative Debt – Both are Good & Bad
Most of us are of opinion to never spend more than we have and that we should stay as far away from debt as possible. This theoretically makes a lot of sense. But not always. We should actually know when to acquire a debt and when to avoid it.
What is Debt?
A debt is an obligation that a person acquires with another or with an entity. It is usually money that the person must pay to the lender. To this money are added interest because that is the profit for the lender.
Not all debts are bad and not all are good.
Good debt or positive debt
Any type of debt that we acquire for a future financial advantage is a positive debt. Applying for a loan to open a business, to buy a house, to educate ourselves or to facilitate the way we work through hiring staff or buying electronic equipment, in other words, for the acquisition of assets, is considered a positive debt. Some people consider that acquiring a debt to educate themselves or their children is also a positive debt. In conclusion, debts are positive, if they are used to acquire some kind of asset.
The important thing is that these assets are valued over time, in the This type of debt (called “leverage”) will help increase the income in short, medium and long term (depending on the type of asset). case of real estate, for example.
Of course, the plan has to be very well structured, so that the income you are going to receive can payoff the debt and at the same time generate profits. If you have a good plan and trust that your idea will bring new income, do not hesitate to acquire a debt if necessary.
Read more: Habits to get out of debt
On the other hand, we have negative debts:
Every time we use a credit card or ask for a loan to buy clothes, a new television, a watch, a Hawaii vacation, a car or any other type of liability, it is absolutely irrational to acquire a debt.
Anything that is not going to generate income it is better to pay it in cash or in case it is paid on credit, pay it as quickly as possible to avoid interest (which in many cases, are as expensive or more than the value of the product itself, depending on how long it takes to pay it).
Many people are tempted to think that certain liabilities are assets. A good example of this is cars. Once the car leaves the showroom, its value depreciates by 35% to 50% of its value. If we buy it on credit, after paying the interest, not only do we realize that it is not an asset, but it was stupid not to have bought it in cash. It is true that most people do not have the possibility to pay for the car in full and inevitably need to resort to credit.
The ideal would be to be able to pay as much as possible initially, reducing the value of the loan. On the other hand, try to pay it as soon as possible, reducing the value of the interest. But this does not mean that we should not buy on credit, but we should be able to distinguish when it is “wise” to get into debt and when it is better to avoid it.
Debt And Emotions
Another difference between negative and positive debt lies in our emotions. Always, negative debts are those we acquire through credit card or personal loan to get momentary satisfaction and even irrational desires.
Suppose you go to the shopping mall and like a jacket you love. At home you have three, but it’s not enough and you feel like you need one more. Then you buy it with your credit card.
That jacket won’t bring you financial benefit in the future, will it? Because you can probably sell it, but at a lower value. In other words, you won’t get your invested money back, let alone make a profit.
This proves that, when you made that purchase, you followed your emotions, you were irrational. You let yourself be carried away by an impulse without realizing that you were putting your finances at risk. Or that you could have acquired something that you really needed.
So remember, it makes sense to acquire positive debt, when it can give you important benefits.
Hi, I am Nikesh Mehta owner and writer of this site.
I’m an analytics professional and also love writing on finance and related industry. I’ve done online course in Financial Markets and Investment Strategy from Indian School of Business.