TomorrowMakers

Are you considering taking a loan? Find out if it's good debt or bad debt

Good debt vs bad debt: What you need to know?

Women have it better than men when it comes to loan eligibility. Under schemes such as Pradhan Mantri Awas Yojana (PMAY), banks have been offering home loans to women at concessional rates of interest. This is because they are comparatively better at repaying loans on time.

Whether you need a personal loan or a vacation loan, the options are endless. However, without considering the pros and cons, debt can have consequences that are far worse than you bargained for. While a loan calculator will help you crunch numbers, you will also need to evaluate why you’re taking on a loan.

  • Debt can be good or bad depending on whether it is part of a long-term financial strategy
  • High-interest rates can make loans unaffordable
  • Loans that contribute to future income are a worthwhile investment

Bad debts have become a national phenomenon. A spate of personal loan defaults has made banks and investors jittery. As inflation and job losses mount, one cannot be faulted for doubting if getting into debt can ever be good. Cutting back on expenses may seem a wise thing to do, but the truth is that you can only skimp so much. 

Related: Avoid these 6 mistakes when in debt

The fact is that loans do have significant upside. Used wisely, they offer a much-needed respite from financial austerity. Millennials have a much more liberal attitude towards loans than previous generations. A study by Home Credit India, a consumer durable loan provider, revealed that up to 50% of respondents have no hesitation taking loans to meet various lifestyle needs.

Women are being actively wooed by banks with a variety of loan products. If you, as a woman, are the principal applicant for a home loan, you may even be eligible for a lower interest rate since women have a comparatively better track record of loan repayment. Arguably, women are much more financially prudent than men.

This brings us to the crux of the matter. How does one make a distinction between good and bad debt, when both can put the things we want within reach? Financial planners recommend that you ask yourself the following question: Is this loan helping me make money? More often than not, the answer would put things into perspective. 

Related: 10 Bank loan schemes for women entrepreneurs

Loans that help you finance an asset such as a house, for example, can be considered good debt. On the other hand, short-term debt like a vacation loan qualifies as bad debt. So, after using a loan calculator to calculate EMIs, consider the following aspects to find out whether your intended loan qualifies as ‘good’ or ‘bad’.

1. Purpose

Taking a personal loan to meet aspirational goals (say, buying the latest smartphone) may be gratifying in the short term. However, since it is meant as consumption expenditure, it yields no benefits over time. On the other hand, investing in an education loan can increase your future income potential substantially. Weigh your reasons for taking a loan carefully to make a sound decision. 

2. Income

If your monthly EMI outgo eats into more than 40% of your take-home salary, adding more debt can be detrimental to your financial health. The lure of low interest rates can be hard to resist, especially if you are in urgent need of funds. To avoid such a situation, look up information online on how to calculate loan EMI and, if appropriate, consolidate your existing debt with the help of a financial planner. 

3. Interest rate

The interest you pay on a personal loan can vary widely, depending on factors such as your credit score, your employer, and your salary. The difference can be as much as 12–24%. While women can get loans on better terms, a balanced approach is necessary to mitigate the interest burden. If the interest rate is a concern, consider a balance transfer early in the loan tenure. Alternatively, if you have surplus funds, opt for prepayment. At the very least, increase your EMIs by 5–10% each year. High interest rates can turn any debt into a bad bargain, unless timely remedial action is taken.

Related: Types of personal loans you must know about

4. Tax benefits

If your loan qualifies for tax benefits under the Income Tax Act, it has some merit. Home loans and education loans qualify for generous deductions, reducing the overall monthly outgo. If you’re self-employed, availing of a vehicle or personal loan for business purposes can qualify as a tax deductible expense. 

5. Hidden charges

Other than interest, loans also come with other costs. You may not be aware that 0% EMI schemes have been flagged by the RBI as misleading. The interest component on such loans is usually recovered in the form of hefty processing fees. The effective rate of interest on such loans is often higher than what you get with regular loans. Source: economictimes.indiatimes.com

Last words

If you have a good credit history, there is no reason why you shouldn’t go in for a loan – provided your debt-to-income ratio is manageable. The latter lets you decide whether the debt you have taken on is good or bad. Looking for ways to pay off your debts and build your savings? Read this debt payment strategies every woman should know about.

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