Recipe For Financial Freedom

After reading this post from Ryan Healy I could not completely agree with him regarding his question that is there a really a good debt? so I decided to define it for myself and put my opinion on his post through this post.

Defining debt:
It is an amount owed to a person or organization for funds borrowed. Debt may or may not include borrowing charges called interest charges or financing charges.

Coming over to the idea of a good or a bad debt:

If the amount owed generates returns more than the interest charges then the debt will act as an income source and in a period of time it will pay off itself.

If the amount owed is consumed to buy assets say for a bike, car or a refrigerator then you have an asset for the debt.

In both the above cases, I would call the debt as a good debt. I would give an example to prove my point.

I deposit $ 1000 in a savings account of a bank which gives me an annual rate of return as 5% as interest. If you look at the other way round the bank has borrowed an amount of $ 1000 from me at a cost of 5% per annum.

Similarly if I borrow $ 1000 from banks through a credit card, the bank charges 30% interest per annum and in this case the cost of debt is 30% for me.

Thus the debt in the first case for a bank is a good debt and it is effectively giving a return of 25% per annum.

A debt becomes a bad debt when the borrower abuses the use of money he has borrowed.

Now coming to the post of Ryan Healy:

Mortgage

Investing in real estate or otherwise should never be dependent on assumption but on a risk return matrix. If I am planning to purchase a house by having a loan on my head then I should not assume that the price will go up instead I should know the probability of prices going up in that area by studying the demand and the availability of housing in that area. It would take some amount of time and effort of yours but this would be worth the investment you make.

College Loan

If you take loan to complete a degree then complete it, if you don’t then it’s your fault and not that of the debt that you have taken. I shall not comment on the role of degree over earning power as it is out of scope of the topic.

Using credit to finance a business

There is no company in the world (either private limited or public limited) which does not uses debt on its balance sheet. The point I want to put here is your decision should be sound enough to put your debt into right businesses or investments.

Investing on Information

Information is the only key factor which differentiates a common person with an expert e.g. a real estate agent has more information about the real estate market than the average buyer and seller and the commission that the agent receive is the value of the information he possess. So investing in getting information is good but not putting that information in use is bad which your fault and not that of debt.

So I conclude that debt is always good but the decisions to use that debt are bad which puts us into a bad debt situation.