May 24, 2007, 2:38 am

Good Debts and Bad Debts

by: The Financial Blogger    Category: Assets and Net Worth
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Today, I’m introducing another concept of financial planning. It starts from our perception of debts. There are a lot of people that are convinced that you need to pay off all your debts as soon as possible. Their monthly payments are their bigger fear and instead of searching how to make money, they are searching how to pay off their mortgage fast. However, I think that debt can be good for you. It all depends on its usage.

Let’s start with the easy part; what is a bad debt? While most people would think that all debts are bad, some of them are worst. Everything related to consumer debts such as credit cards, lines of credit, car loan or car lease are considered bad debts. They are high interest debts and most of the time, what you purchase will require maintenance fees.

Bad debts are related to goods that don’t produce income. Therefore, you pay interest, you pay for maintenance but you are not making money out of it. The only benefits are psychological and physical comfort. No money in your pockets.

However, some debts are related to an asset. As previously mentioned, an asset creates wealth. Investment loans, RRSP loans and borrowing money to invest in a company are examples of good debts. You still have to make your monthly payments, however, you will benefit from extra cash flow in the long run.

In addition to that, most governments have tax reduction programs related to good debts. In Canada for example, you can deduct the interest paid on an investment loan from your total income. So as you are making money on your investment, you are paying fewer taxes to the Government. I’m telling you, tax laws are made for rich people!

As you can see, it is not really the amount or the interest rate that make a debt good or bad. It is more related to the usage of the money that you are borrowing. Another incentive should be that most of the time, interest rate on good debts are lower. It definitely pays to borrow!

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