Borrowing is common but it is very important to know what is the difference between good debt and bad debt. It is right to take a loan for some things but some can create financial troubles for you.
What is good debt?
In simple words, a good loan is a prudent investment for your future or one that strengthens your financial status even if it is for a long period. Good debt never affects anyone’s financial condition.
In general, a good loan is one for which we have a specific reason to borrow money, be it from the bank or NBFC, it does not matter. For example, taking a loan to buy a house or car involves good debt. Because after paying EMI for a few years, you become the owner of that house or car. So it is good to take a loan for these things.
Examples of good debt:
– Home loan
– Car loan
– Education loan
– mortgage loan
– Business loan
What is bad debt
Bad debt is taken for what is not worth it. This kills all your money. Bad loans can be defined on the basis of loans which do not have any specific purpose. Their interest rates are so high, due to which you have to pay EMI too much and it becomes difficult to get it.
Examples of bad debt:
– Borrow for a loan that you cannot afford.
– Taking a loan for shopping or a great party.
– Loans for buying expensive gadgets or devices.
How to avoid bad debt
To avoid turning a loan into a bad debt, you should keep these things in mind before applying for a loan:
1. Is it really important for you to take this loan? Is there no other option than taking a loan?
2. Have you compared the interest rates of other lenders. If yes, is it equal to your lender or is it less on the same loan than other lenders.
3. Can you repay the loan amount without any hassle.
4. Can you repay your budget EMI over the entire period.
If there is no answer to any of the above questions, then your debt is bad debt and you should avoid it.
Understand and review it before taking a loan
Not all debts are bad debts. Some loans are worth taking and in the end you get what you have paid. If the loan you are considering taking does not meet the requirements, purpose, interest and repayment conditions, then it is a bad loan. The best example of bad debt is that you took a flagship smartphone for a period of 4 years, which became old only 2-3 years after its launch. Nothing was gained from this loan, except for the waste of money.
At the same time, it is also right to take a high interest rate personal loan for medical needs, because money cannot exceed one’s life. No one would mind the burden of loan more than the health of their loved ones.
Use equity or mortgage loans: Whenever you need money, always borrow money from equity loans such as home equity loans or other mortgage loans. The reason behind suggesting that interest rates are lower than other loans and EMI also does not loose your pocket. The duration of these loans is also longer as compared to other loans.
What to do if you are stuck in a bad debt trap: If you are stuck in a bad debt trap and are having difficulties in repaying the loan, then there are some ways that can get you out of these troubles.
Go for refinance or loan consolidation
If you are running many loans and are having trouble paying EMI, then you should choose the path of refinance. Refinance or loan consolidation is nothing but taking a new loan at a lower interest to repay the outstanding loan amount from another or the same bank. In this way you will avoid paying the loan at a higher interest and will have to pay a lower EMI on the new loan.
Talk to your lender
If you are unable to repay the EMI of a particular loan because you cannot afford it, then talk to your lender. You can ask the lender to reduce the EMI and extend the period. If you can do this, you can repay the loan easily. But in this you will have to pay more money. That is because by increasing the duration the EMI will decrease, but the interest will have to be paid more. But by not paying EMI and continuously filling the penalty which will spoil your CIBIL report and action will be taken, this is a better option.
Ask your lender for settlement
When you are stuck in a swirl of debt and are unable to repay the loan, then it is considered the best option. For this, you will have to talk to your lender and persuade them to accept less than the total outstanding amount including principal and interest, but more than the principal amount. If the bank is ready for this, then you can easily get rid of the burden by paying the loan.
What can happen with bad debt
Money will be wasted: Bad debt is one whose interest rate is always higher. So you have to pay more money as EMI from your monthly income. It slowly wastes your money.
Legal issues: If you are unable to repay the loan, then it is a bad loan and if the interest value is too high, then in that case the lender can also take legal action against you to recover the amount.
Forfeiture of Guarantee: If you have loan and if you cannot repay the money, then the thing you have kept with the lender as a guarantee will be confiscated and its ownership will go to the lender.
Bankruptcy: If you do not repay the debt, then the situation of bankruptcy can come in front of anyone. This is the last step. In this case, the bank will take possession of the property and money of the customer. This will happen when the loan is not guaranteed in lieu of the loan or the guarantee given is not equal to the loan amount.