Will it takes Money to produce Money ? Everything about Good Debt !!

Everyone wants to be debt-free, but sometimes debt is good to have because it acts as a well-planned financial strategy where investors can accomplish long-term goals by adding different kinds of assets to their kitty. Like bad debts act as a big burden in life, good debts require lots of planning and strategy.

Before talking about good debts, let's understand why debts are mostly considered bad. When a borrower is unable to pay an EMI amount, leading to default, which ultimately impacts their credit score negatively. A simple example is when borrowers or credit card holders are unable to pay their full credit card bill because of interest payments, which can prolong the debt.

Why Good Debt is so Good ? If an investor wants to have good long-term wealth, then the right amount of debt can easily help in building it without taking on bad debt. In simple words, debt becomes bad when an investor takes money from his or her future self to buy goods and services in the present day, which provide the investor with no future income benefit. If an investor is able to re-pay the amount borrowed, it will be considered good debt. Ultimately, good debt can be considered a loan that is used to finance something that will offer a good ROI (return on investment). The best examples of good debts are home loans and education loans.

When an individual or investor takes out a home loan in hopes that by the time the investor's mortgage is paid off, the home will be worth more because, in 70% of the scenarios, the rate of the property always appreciates, Also, borrowers can save tax under Section 24(b) up to 2 lacs by showing the interest portion while filing their income tax return.

Talking about the real-time example, if I took a home loan of Rs 20 lac back in 2009 for buying a property worth Rs 45,00,000 for 20 years, ultimately, if I wait for 20 years to re-pay the loan amount, then, based on compounding interest methodology, I will be paying approx. Rs 48,00,000 to the bank, which is more than 100% of the actual amount borrowed. 

As a good pre-payment strategy and long-term goal, I paid off all the loan amount in 10 years, which ultimately saved a good amount, and today the value of the house or asset is more than Rs 65,000. We need to consider that the fact that there was a pandemic also weakened the real estate market. So ultimately, good debt helped create wealth in terms of assets and saved taxable amounts on a year-on-year basis.

On the basis above, if an investor took a home loan for 20 years with an interest rate of 7.55%, If he takes 20 years to re-pay, then the total interest paid will be approx. Rs 18,81,535; however, if the borrower decides to re-pay the complete loan amount in 5 years, considering no changes in the interest rate portion from the government, investors will be able to save approx. Rs 11,71,846. Similarly, if complete re-payment is done after 10 years, the borrower will be able to save approx. Rs 5,81,265.

Similarly, education and auto loans can both be considered in the good debt category as both are taken for career growth or business expansion. Both student and auto loan borrowers have good earning potential; however, sometimes both borrowers may face burden or fall into the bad debt category if the loan is not repaid on time, considering the rate of interest is higher compared to a home loan.

"Debt is like any other trap, easy enough to get into, but hard enough to get out of.