It is often the case that when you go to buy a big ticket item, you are given the option to borrow money. Whilst it is tempting to look at these offers, it is important first to understand whether the loan is a good kind of debt or a bad kind of debt.
When you buy a new car or new iPhone , it immediately loses some value when you take it out of the showroom or open the box. Such purchases are called depreciating assets. Depreciating assets includes things like cars, clothes, furniture and electronics. Whilst these purchases continue to provide value and functionality to you, they lose value in the eyes of others because they are used and might have some wear and tear.
A debt is generally considered to be bad debt if you are borrowing to purchase a depreciating asset. Borrowing money to pay for something that is losing value cannot lead to wealth generation.
On the other hand, appreciating assets are assets that have the ability to increase in value overtime. Appreciating assets include purchases like Real Estate. In this case borrowing money could help you to build your net worth over time and is therefore called a good debt.
This does not mean of course that you should go ahead take a loan whenever purchasing an appreciating asset. There are many factors to consider when taking on debt including how much it will impact your cash flows, whether the return on your investment will be worth the cost of the debt, how many loans you already have outstanding and whether you want to take on the stress of having a liability on your head. But we hope that this post has helped you understand that the type of assets you purchase using debt can have a major impact on your finances and therefore should be one factor that should be considered carefully.