In simple words, debt means owing money from one party to another. The other party can be lender or creditor and usually, debt is the money that you need to re-pay to someone. Generally, the majority of debt consists of interest which means the borrower will have to pay more than what he borrowed from the lender. Mostly, interest is the cost which is paid by the borrower for borrowing money and interest is mostly charged as a rate on the borrowed amount.
However, borrowing is good, it helps you build a credit report which might come handy at a later point of time.
Should you borrow money?
It is an old school saying that you should avoid borrowing money. Borrowing money can put you into further financial troubles and will let you pay more than what you would have paid if you would have waited. As said earlier, a lender will charge interest on the amount he has given you as a loan. In case there is no interest payment involved, then there would be stress involved. Many times, the situation is so critical that you keep on paying the interest and are not even able to initiate the repayment of the principal amount. When there is uncontrolled access to the money borrowed, it would have a very negative impact on your life and lead to difficulties to manage debt.
However, as there are two sides to a coin; similarly, borrowing can be advantageous in cases like borrowing money and using the money for making investments. If you are availing a business loan and using that money for making investments then it is considerable. Investing by borrowing should only be exercised in those cases where the returns are higher than the loan and the risk involved is less. So, borrowing money should only be done in those cases where you expect to make more money by utilizing the borrowed money.
Good debt versus Bad debt
Good debt is those which can be considered as a productive investment in the earning power of a person in the future. The debt which is used to finance something that is going to increase its value in the future or will generate some long-term benefit is known as good debt. In simple terms, when debt increases your net worth or has some future value it is known as good debt. Also, good debts are considered as low-interest debts.
Education loans or student loans, Home loans, etc. are some of the most common examples of good debt. These loans or debts are otherwise known as good debts due to two main reasons.
Good Loans have a tax advantage
Tax Advantage on Home Loans
|Category||U/S||Amount||Terms and conditions for the deduction|
|Principal||U/S 80C||INR 1.5 lakhs||The property should be in possession for a minimum of 5 years to claim this benefit.|
|Interest||U/S 24B||INR 2 lakhs||The Home Loan must be availed for the purpose of buying a new home or reconstruction of an old one and the same needs to be completed within a period of 5 years.|
|Interest||80EE||INR 50,000||For Home Loans of less than INR 35 lakhs such that the price of the property is less than INR 50 lakhs.|
|Stamp Duty||80C||1.5 Lakh||This amount can be claimed only in that FY wherein the expenses have been made.|
|Interest||80EEA||1.5 Lakh||The stamp value of the house needs to be less than INR 45 lakhs.|
Tax Advantage on Education Loans
Parents are eligible to get a tax benefit on education loans for the purpose of higher education for their children. The principal repayment has no tax benefit. However, the interest portion can be considered tax free U/S 80E as Education Loan for an entire tenure of 8 years from the date the loan was availed.
In case of a home loan, student loan; you are investing in something which will increase its value in the future or will give you long-term benefits like your child’s education. A home loan gives you your own home which will increase its value in future and has long-term benefits; student loan will help you in obtaining the college degree which will become your reason for income in future.
Similarly, these loans are large amounts and you will take a long time to re-pay back the loan. By making the EMI payment or installment payment every month, you are confirming your ability to repay the loan. This shows your creditworthiness and gives you a good credit score.
Bad refers to those items which tend to provide gratification instantly and do not offer any long-term or financial return. These debts will drag down your financial health and also have high-interest rates. When you are financing discretionary expenses that will lose their value over the period of time, you are acquiring bad debts.
Personal loans, credit cards, cash advance loans, etc. are some of the common examples of bad debts which can be a reason for financial stress in your life. Credit cards can be considered to be the worst among the categories of bad debts.
- A credit card is mostly never used to purchase any appreciating assets. It is mostly used for purchases such as clothes, accessories, gadgets, home furnishings, etc. These commodities do not offer any long-term benefits and their value decreases with time.
- Credit cards have very high-interest rates and the more expenses you keep on putting on your credit card, the interest goes on increasing. Debts like home loans and education loans have a nominal interest rate and are comparatively easy to payback.
- Moreover, the minimum payment for credit cards is very less and it will take many years till you clear off the entire outstanding dues. But you will have to pay the interest for those many years which are a pain in disguise and will hamper your financial health.
If you have a credit card, then it is inevitable that you use your card wisely and make your outstanding due payment diligently on-time. It is a very effective tool but it needs to be used carefully. Moreover, you should use your credit card for purposes like availing the benefits and redeeming the reward points.
Similarly, personal loans are also considered as bad debts under certain scenarios like opting for a personal loan to make discretionary purchases like a vacation, exotic wedding, etc. These loans have a higher rate of interest and this spendthrift habit can affect your financial health adversely and you would face difficulties to manage debts. However, sometimes personal loans can be taken for certain specific goals like improvements to be made in the home, manage debt by consolidating and paying back all previous debts in one round.
Cash advance loans can also help in solving your financial emergency instantly but they are considered to be bad debts in the long run as they have a very high-interest rate. This high-interest rate will affect your ability to make prompt monthly payments and will lower your credit score eventually. You can get trapped in a debt cycle and then it would be a difficult task to manage debts judiciously.
Why to repay your debt quickly?
One of the feasible and effective methods to manage debts is to make sincere efforts for the repayment of your debts quickly. It is necessary to repay your debts in time as it prevents you from getting into a debt trap which is a vicious circle.
No more paying interest on debts
By paying your debts quickly and on time, you are going to get rid of the interest that you have been paying along with the debt. Usually, in debt repayment, the interest forms the larger portion than that of the principal amount. So, this payment of interest will stop if you manage debts properly and repay them fast.
Reduce the adverse impact on your credit score
If you keep on delaying the repayment of debts, it can have an adverse impact on your credit score. For instance, if you are not making your credit card outstanding dues payment on time and delaying it, then it would affect your credit score.
Get rid of financial stress
Debts are a reason for financial, mental stress and can even become the cause of health issues. It is wiser to get off this stress and problem as soon as possible by making the repayments quickly.
Steps to repay your debt quickly
Let us check out some of the simple methods by which repayment of debts can be made quickly.
Step 1: Automate payments
This is an efficient method by which you can pay off your debts on time without any delay. You can set up standing instructions with your bank account and your recurring bills, debts can be paid automatically according to your selected frequency.By setting up automated payment, you are saving a lot of time. You will not have to visit various websites and check the payment due date and make the payments. The payments will be done automatically without any wastage of time.
If you are setting up an automated payment system, then they will occur on a scheduled basis and your bill payment deadline would never be missed. As a result, you will avoid paying late fees for missing payment deadlines.
When you are signing up for automated payment, you have the liberty to choose the date when the payee would withdraw money from your account. So, you can schedule the date according to your convenience such as a date after which you have received your salary and your account has sufficient money.
When you are paying your bills regularly without any delay by using the automated system, your credit score would be improved. Even if your credit score has had some negative marks due to the debts, your consistent bill payments will improve your score.
Moreover, this method of automated billing helps you in avoiding paper bills and sending bills via mails. So, this is an environmentally friendly approach to manage debts.
Step 2: Pay off the debt with the highest interest rate
Many people prefer making payment of those debts first which have low-interest rates i.e. the debt snowball method, however, it is wiser to follow the debt avalanche method and pay off those debts which have a higher interest rate. This will help in saving both time and money. When the debt payment of one credit card has been completed, you can use it to roll the payment into the next debt payment.
Step 3: Pay as much as you are able to
If you are making any savings that are of considerable amount, you can use the money for creating an emergency fund. After that, your next priority should be to pay as much as you can afford for clearing your debts. The more you are paying; the process to manage debts and get rid of debts would be faster.
Step 4: Cut off your expenses
You can downsize your lifestyle and cut down your expenses to save some money. The savings can be used to manage debts and pay off your debts quickly. You can differentiate between your necessities and wants; then prioritize your necessities. Certain wants like holidays, shopping, dining out, etc. can be avoided for a certain period until you re-pay and manage debts. You can start doing this by making a monthly budget, committing to that budget and tracking your monthly expenses.
Step 5: Pay more than the minimum amount to be paid
You might be having any type of debt; the best method to manage debts is by always paying more than the minimum amount which needs to be paid. By doing this, you would be able to pay off all your debts faster and would also not be under the stress of paying unnecessary interest on the debts.
Step 6: Earn some extra money
When you are in a difficult situation due to debts and want to manage debts, the best way out is to increase your income. Along with your profession, everyone has some skills or areas of interest and that can be used as an additional source of income. You can find out any part-time or additional work according to your interest and start doing that for obtaining some extra income. This extra income can be used to pay off your debts and manage debts.
Step 7: Stop the use of credit cards
If you really want to manage debts and pay-off all debts faster, then the best way for this is to stop the use of credit cards completely. The more you use the card, the more balance goes on adding up and the debt keeps on increasing. This is a vicious circle and a trap that can be avoided by immediately stopping the use of all credit cards. The use of credit cards might be your habit but you can motivate yourself to stop using a credit card. By this, your debts do not go on increasing and finally, you are able to clear all debts and manage debts.
Step 8: Debt Consolidation
Debt consolidation is an easy method for paying off debts faster. You can roll up multiple debts into one and make the payments by consolidating the debts. A good credit score will help the bank to give permission for debt consolidation.
Step 9: Lower interest rates on credit cards
You can even try and negotiate about the interest rate of your credit cards. You can contact the credit card provider and negotiate about the credit card interest rates. If you have been a consistent payer of your bills and debts, then you can easily negotiate with your credit card provider to lower your interest rates. By doing this, your debts are going to reduce and you will be able to manage debts.
Step 10: Use bonus to repay your bad debt
Every person comes across some “found money” like an annual increment at work, bonus at work or inheritance. You can use that extra money for paying off your debts easily. If your “found money” is a big amount you can use it to pay off your big debts easily and then smaller debts can be paid off gradually.
Step 11: Leave expensive habits
When you have huge debts and you are not able to pay off in a fast manner, it is necessary for you to change your habits. If you have some expensive habits like partying with friends frequently, drinking, smoking, etc. then these habits can be dropped off. It is not so easy to give up all your habits instantly, but the frequency can be reduced and gradually efforts can be made to leave the habits. This will save your money and would be advantageous from a health perspective as well.
Hence, there are times when debts seem like a trap and there seems to be no way out of it. However, in such a situation it is essential to face reality and make perfect plans or strategies to come out of this trap. Sincere efforts and judicious use of the money you earn can help you in paying off your debts faster and thus, coming out of this trap sooner. Remember, the faster you get rid of your debts the faster you can live the life of your choice.