Debt often gets a bad rap, but it's more nuanced than that. When managed properly, debt can be beneficial and even help build wealth
Knowing the difference between good and bad debt, and how to manage each, can help you take control of your finances.
Let’s look at what is good and bad debt and the strategies to manage bad debt effectively.
Good debt helps you achieve your financial goals, such as buying a home, funding your education, or starting a business.
These debts are usually tied to investments that can grow in value over time and often come with lower interest rates. These debts are seen as investments in your future. In addition, some good debts also offer tax benefits and can help you build your credit for larger purchases, like an HDB flat or a car.
Here are some examples of good debt:
A home loan can be a smart tool for building wealth, especially through house hacking or buying rental properties. In these cases, rental income often covers the mortgage and maintenance costs, turning your property into an income-generating asset. Additionally, properties typically appreciate over time, making them a sound investment. Housing loans also come with tax benefits, like deductions for loan interest and property expenses.
Education is an investment in your future, especially when you focus on skills that increase your earning potential. Student loans usually come with lower interest rates. Its interest can be tax-deductible too!
Taking on debt to start a business is a common way to build wealth. Entrepreneurs often get loans at reasonable interest rates to fund expansions, like buying new equipment or acquiring a competitor. Borrowing money allows business owners to finance growth without giving up ownership, offering more flexibility than equity funding. However, it’s always important to weigh the risk involved before taking out a loan.
Bad debt often comes with high interest rates, making it costly and challenging to pay off. Bad debt results when you borrow more than you can repay or invest in items that depreciate in value.
Good debt can turn bad if it's not managed properly or responsibly, too.
Here are some examples of bad debt:
Credit card debts typically carry high interest rates. Many credit cards offer low introductory rates at the start, but these can rise to over 24.99% after the promotional period ends, making it easy to accumulate unmanageable debt. Additionally, missing a minimum payment can often result in even higher interest rates, further compounding the debt issue. According to SingStat data released in May 2024, credit card debt saw a year-on-year growth of 15.8% in Q1 2024, reaching S$14.6 billion.1
Singapore has excellent public transportation. Unless it’s necessary for work, financing a vehicle that is unaffordable and doesn't add to your financial well-being can be considered bad debt. A car’s value depreciates the moment you drive it off the lot. Borrowing money to buy a vehicle can lead to paying more in interest than the car is worth over time.
Borrowing at high interest rates for non-essential purchases is considered bad debt. For example, using a credit card with a high interest rate to buy clothes and gadgets, or to go on vacations. There is nothing wrong with buying non-essential items if you can afford it. But getting into high-interest debt with purchases that don’t build your wealth can quickly strain your finances.
Fixing bad debt can feel overwhelming, but with the right steps, it’s achievable. By focusing on high-interest debts first, negotiating with creditors, and sticking to your financial goals, you can improve your situation.
Here are some simple tips:
One of the best ways to tackle bad debt is to create a clear repayment plan that targets high-interest debts first.
List all your debts and their interest rates. Start paying off the debts with the highest interest rates first.
This way, you’re reducing the total interest you pay over time. You can also make extra payments on these high-interest debts while keeping up with the minimum payments on others. This would speed up your debt repayment journey.
Another helpful strategy is to call your creditors and ask for lower interest rates. Many creditors are willing to lower your interest rates if you've been making on-time payments!
A lower interest rate means smaller monthly payments and a quicker path to being debt-free. You’ll never know what’s possible if you never ask. So, don’t hesitate to reach out and ask for a better rate.
Staying focused on your financial goals is key to avoiding future debt.
Having targets to work towards, and a budget you can spend from helps develop good financial habits. With an end goal in mind, it gets easier to cut back on expenses and can possibly help you gain a better footing with your debts!
It’s important to remember that not all debt is bad.
Good debt propels you toward your goal, while bad debts hold you back.
Before you take out a loan or spend on credit, ask yourself if you are spending within your means. Because even debts that might seem to advance you towards your goals can be bad debt if you can’t afford it, or if it’s not managed properly.
If you noticed that you’re caught with a few bad debts, we hope the tips above gave you some ideas on ways to manage them. It’s also a good idea to talk to your financial consultant for a more holistic plan to get your finances back on track!
With a little effort and planning, you can turn your debt situation around and build a stronger financial future.
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References:
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