Bad Debt vs. Good Debt: Not All Debts Are Bad in Singapore (2018 Breakdown)

What is the first dirty four letter word that comes to your mind?

Well, for us it’s DEBT.

Many shun at the sight of this word and treat it as a huge taboo. This is especially so after the 2009 economic crisis and there’s no generation that has feared debts as much as the millennials. Some would say they fear debts as much as they fear death. This, however, this is caused by a lack of understanding of the difference between a good and a bad debt. Yes, there are good debts too.

Nobody likes to be in debt. However, there are situations in life where you will need some extra cash. If you’re lucky, a friend or a family member will be able to lend you the money. The advantage of this is that it won’t affect your credit score. If you don’t have a relative or friend to lend you the money, you will have to turn to a financial institution.

The good news is that not all debts are created equally. There are debts that financial institutions consider as good debts, and those that they consider as bad debts. It’s important to be able to distinguish between the two.

What Is Good Debt?

A debt is considered to be good when the money borrowed is used for a sensible investment that will benefit you financially in the future. This is also true for money that has been used to purchase wealth-building assets. These loans often have a clear purpose behind them. They also have a realistic schedule for their repayment. Ideally, these loans should help you generate income over time. The general reasoning is that these debts can pay for themselves.

Types of good debts include:

1. Home Loans

Many people dream of owning their own homes. However, very few can afford to do so without taking out a loan to pay for it especially with the high property prices in Singapore. The good news: a home loan is considered a good form of financial investment. It is therefore more prudent to pay a mortgage rather than renting a place to live. It is advisable not to rent a place for the long term as it is not a cost effective option and might put a strain on your wallets in the long run.

Home loans are often paid over a long period of time and the monthly installments are relatively affordable. The interest rates on these loans are also generally low. What’s more, the market value of your house will increase over time. This increase in value should hopefully cover the interest that you have to pay over the years. Another benefit of home loans is that they are tax deductible. This means that you will save on your taxes while you continue to repay your loan. Should you decide to sell your home in the future, you are likely to make much more than you paid for it. Property prices are on the rise in Singapore. In this way, your loan would have helped you generate wealth.

2. Education Loans

Getting an education isn’t cheap. Tuition fees can cost up to S$20,000 annually. If you are thinking of sending your children overseas, you can expect to pay tuition fees amounting to about S$40,000 annually, excluding all other lifestyle expenses. That being said, it doesn’t pay to scrimp on one’s education. An education can significantly increase your capacity to earn as you will be eligible for more lucrative employment opportunities. You will be more skilled and capable when you graduate, opening more doors and opportunities for yourself.

3. Business Or Investment Loan

Borrowing money to start or expand a business is often wise. This is especially if your industry is booming. There may be certain opportunities that require you to invest as soon as possible. Timing is key. The money you’re borrowing will be turned into profit which in turn can be used to generate even more profit should there be adequate planning.

4. Renovation Loan

Renovation loans have been gaining popularity in Singapore over the past few years. People want to live in comfortable and ideal homes. Renovation costs are high in Singapore and sometimes home owners may need to acquire a loan. Getting a loan for renovation is considered a good form of debt because having a comfortable and beautiful place to live in helps one relax, relieve stress and have a good rest. Emotional and physical well-being will also improve. After all, a home is a place where one goes home to at the end of a long day at work or school and a home renovation might just spruce up the surroundings and make it look nicer and more pleasing to the eye.

It will also allow the owners to bargain for a higher selling price since the house has been remodelled and given a new coat of paint, should they decide to sell the house in future. While none of the outcomes above are guaranteed, these loans often have a good payoff and are generally considered good debts by lenders.

What Is Bad Debt?

Loans that are considered bad debt are those that are either unsustainable or unnecessary. This means that you could probably do away with what you use the loan to purchase. They are items that you don’t need and are likely to depreciate in value over time. They may also be items that could cause you to incur huge financial charges or high interest rates. All these factors make repaying the loan difficult.

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Types of bad debts include:

1. Credit Cards

Credit card debt is an avoidable debt. However, it is also one of the fastest growing debts amongst Singaporeans. This debt piles up before you even realise it and many people have fallen into the endless cycle of credit card debts. They tend to spend more than they can afford, or are unable to repay as fast as they spend. All because credit cards fuel impulse buying.

2. Car loans

While you may feel like you need to purchase a car and get a loan along the way to help with your finances, car loans are still considered bad debt. This is because cars always depreciate in value as they continue to be used. Cars also come with other hidden costs such as maintenance fees, fuel, road taxes and car insurance. You will therefore be sinking money into an item that will never increase in value. Nonetheless, there may be situations where purchasing a car is necessary. For example, when the family is large and a car is needed to help travel around.

3. Personal loans

Personal loans are given for various reasons. You could take out a personal loan simply to tide you through a period that you’re experiencing financial difficulties or for emergency purposes. You may even take a loan to pay off another debt. Or you could be taking a personal loan to purchase items that you do not need, such as luxury goods.

Personal loans are versatile in their applications. However, because they are often given as unsecured loans, they attract high interest rates. This makes them bad debt. You will end up paying a large amount in interest that will probably make you think twice about ever taking out such a loan again.

Ultimately, it is helpful to understand that not all debts are bad and some may be beneficial especially in the long run. Knowing the difference between good and bad debt will help you better determine whether you require a loan or not, and properly manage your finances in the long run.