Borrowing money has become easy and a common practice to seek funds without considering the consequences. However, while borrowing, you must ask yourself two important questions – what is the purpose of the borrowing and how will that fund help you achieve your goals?

Some people feel that borrowing is a not a good idea. However, not all debts are created equal. Understanding the distinction between good and bad liabilities or debt is crucial before borrowing money, particularly when we have limited amount of money at our disposal.

There are many advantages of borrowing and making use of that money to grow. Good liabilities refer to debts taken for purposes that have the potential to generate long-term value or enhance your financial well-being. These include:

Education and Home Loans: Borrowing to invest in education can be considered a good liability as it typically leads to higher earning potential and career advancement opportunities. Likewise, acquiring a home loan to purchase residential property is often deemed a good liability due to the potential for property appreciation and the creation of a tangible asset.

Business Loans: Borrowing to fund a business venture or entrepreneurial endeavour can be considered a good liability if it leads to the generation of income and business growth.

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What Are Bad Liabilities?

Bad liabilities, on the other hand, are debts incurred for non-appreciating assets or expenses that do not contribute to long-term financial well-being. These include:

Credit Card Debt: Accumulating credit card debt for discretionary expenses or non-essential purchases is often classified as a bad liability due to high-interest rates and the potential for long-term financial strain.

Personal Loans: Taking out personal loans for lifestyle expenses, such as luxury items, vacations, or dining out, is considered a bad liability as it does not generate lasting value or assets. Often short-term, high-interest loans, targeted at individuals facing cash flow challenges, can lead to a cycle of debt and financial instability, making them a prime example of bad liabilities.

What to Consider Before Borrowing

Before taking on any debt, carefully consider the purpose of borrowing. Assess whether the expenditure will contribute to long-term financial goals or merely satisfy short-term desires.

Affordability and Interest Rate

Evaluate your financial capacity to repay the debt. Consider factors such as income stability, existing financial obligations, and potential fluctuations in interest rates or repayment terms. Compare interest rates offered by different lenders and opt for the most favourable terms. Be mindful of variable interest rates and their potential impact on repayment obligations.

Repayment Tenure

Choose a repayment tenure that aligns with your financial goals and cash flow requirements. While longer tenures may result in lower monthly payments, they also lead to higher total interest payments over time.

Impact on Credit Score

Understand the implications of borrowing on your credit score. Timely repayment of debts helps build a positive credit history, whereas defaulting on payments can adversely affect your creditworthiness.

Emergency Fund

Maintain an emergency fund to cover unforeseen expenses or financial setbacks. Relying solely on borrowing for emergencies can exacerbate debt levels and financial stress.

Adhil Shetty, CEO, Bankbazaar.com, says, “Bad liabilities arise when borrowing lacks a repayment strategy, leading to potential defaults, whereas good liabilities foster wealth creation and financial growth. Bad loans occur when borrowers overlook interest rates and repayment terms, risking adverse effects on credit scores and financial stability. In contrast, good loans address long-term financial needs and facilitate asset acquisition, like homeownership, entrepreneurship, or education for career advancement. By understanding the difference, you can navigate your financial journey wisely, ensuring wealth growth and future security.”

Distinguishing between good and bad debt or liabilities is essential for making informed borrowing decisions that align with your long-term financial goals and aspirations. Remember, thoughtful borrowing today paves the way for a brighter financial future tomorrow.