Comparison Between Good Loans and Bad Loans. All You Need to Know

While we all know the old saying “to live within our means,” there are times when a loan serves as an excellent option to get what we want. Loans are nothing but debt. And if you are worried about whether loans are good or bad, then know this: there would always be a section of people arguing that no debt is good debt.

However, for some high-value items such as a home, car, etc., loans are the only means by which common people can afford them. And such loans are useful as they bring value to the person buying the high-value items.

On the other extreme, many people use loans as a source of money for their irresponsible and unreasonable expenditure. The justification here is – why not spend when you have instant access to money through credit cards?

Considering these two extremes, it’s not fair to label loans as a good thing or bad thing unless we dive deeper and consider various factors involved in taking loans.

What is a Good Loan?

There is an old maxim – “Money Makes Money.” So, if your loan money can generate an income, consider it a good loan. A positive loan helps you create an income and make more money than the interest you repay. In general, a loan can be considered a good loan when it increases your worth.

With that in mind, we can categorise the following loans as good loans:

1. Education Loan

Education is considered to be a doorway to get new opportunities. An educated person has a good potential of earning a high income and finding new well-paying employment. Considering this, loans for education go for raising your worth. Hence, taking a loan for educational purposes that is likely to add value to your earning potential is considered a good loan.

However, one must be careful while choosing the education program and see if it’s worth taking a loan. If the education program shows no clear career path or earning opportunities, the program is not worth the risk of debt you are taking and will turn your education loan into a bad loan.

2. Business Loan

Starting your own business is a dream of many. People who want to test their potential and try out newer opportunities, who want to work on their terms, or create their destiny themselves choose to start their own small business. As small business brings new opportunities to generate income, a loan taken to start your own business is also considered a good loan.

However, just like the education loan, this loan also comes with risk. Risk of not being able to repay it. Many small businesses have to close down within a year of their inception. So, here again, you have to weigh the risks against the chances of getting success.

In general, if your business is less capital intensive or low on operational cost, there is a high chance of your succeeding. Another point that can prove to be your great asset and help you succeed in having good knowledge or experience in your field of business.

3. Home/Property Loan

Home loans or real estate loans are very common these days. People generally buy homes or property for either their living or renting out. These loans also help you increase your worth if the value of your property goes up in the future. Besides, home loans serve as a new income stream if you rent it out.

So, with home loans, you get returns in two ways – 1. Value appreciation 2. Rental income.

Moreover, if you take loans for commercial property, it may also create a fresh income stream. However, as with education or business loans, conducting proper research is very important before you go in for a home/property loan.

What is a Bad Loan?

While a good loan helps you increase your worth, there are a few loans that depreciate your worth. In other words, loans taken to purchase something that does not help you generate income are not worth going for. These loans can be termed bad loans.

A few loans that fall under this category:

1. Car/Vehicle Loan

A car or any other vehicle is something whose value starts to depreciate as soon as you bring it from the showroom. The value of a vehicle or any other vehicle not only depreciates fast, but it also becomes valueless after a few years. Therefore, it’s not recommended to buy a car on loan. If it’s necessary, you should try to find a car loan with the least or no interest.

Or else, if you can afford to spend a bit, purchase a car that is less expensive and buy without a loan. An expensive car beyond your reach may give you a good feel for a few days but will start creating a hole in your pocket soon. In case you are putting the vehicle to commercial use, you should do proper calculations of how you are going to repay and see if it is worth buying on loan.

2. Electronics, consumables, and clothes

Purchasing electronics, clothes, or other consumable items on loan is also a bad idea. The reason is electronics lose a big chunk of their value as soon as they are sold, and clothes are already sold at a price much more than what they are worth. Some people buy consumables like groceries, vacations, food, etc., on loan, but they must assess if they are worth paying interest over. Overall, these items are either consumed or they depreciate over time. They do not help you increase your worth. So, such things should never be bought on loan.

3. Credit cards

Credit cards are the worst type of loans. The interest paid on credit cards is too high compared to the other kind of consumer loans. The payment schedule is also made so that banks can incur a maximum cost from you in lieu of interest.

There are some loans which we can’t classify straight away as good loans or bad loans. These can be good for a few people but bad for others depending on various factors.

Such types of loans are:

Loans to pay loans: Some people who have already taken loans at a higher rate might take another low-interest loan to pay off the earlier loan. Such loans can prove beneficial for people who can pay off their high-interest loans in such away.
Reward points of credit cards: Credit cards run various reward programs for consumers. Consumers can earn reward points, get free tickets for airlines or movies, get free goodies, cashback, and other benefits. But these reward points are worth only if you can pay your credit card bills timely. Else, you will be paying way more than the value of benefits earned through rewards.

Also read:

1) What is a business loan? How to apply for a business loan?
2) Home Loan: Steps to apply, Best Interest Rates on Home Loans & more
3) What is Business Loan? A Complete Guide.
4) How To Get Small Business Loan From Government?