Before you borrow funds, it is extremely important for you to distinguish between bad debt and good debt. While there are some things which are worthy of going into debt for, there are some other things which can leave you in a huge fiscal dilemma. By its definition, debt is the process of an individual borrowing money from someone else. Among majority of us, debt is an essential part of our life. We usually borrow funds so that we are easily able to buy services and goods which we couldn’t afford at the present moment.
Individuals usually borrow money in lieu of the promise of repaying the borrowed amount in the near future, when they expect to have that money. In this sense, all debt will seem to be similar as we borrow now and repay in the near future. Just as debts have a positive and negative impact, they are categorized into good and bad debt.
Good debt – What is actually considered as good debt?
Generally, good debt is that debt which boosts your net worth and allows you to generate value. Good debt lets you handle your personal finances more effectively, utilize your wealth and purchase things which you require for tackling unforeseen emergencies. Few examples of good debt are taking out a mortgage loan, purchasing things which save your money and time, investing in yourself and taking out educational loans. Let’s elaborate:
- Taking out a mortgage: Majority of us fail to afford a home with cash and this is when we borrow money from a mortgage lender and promise to repay the amount through an extended period of time, set by the lender. The interest rate that one pays to a mortgage lending company is tax-deductible and hence helps you save money on your tax bill.
- Borrowing which saves your time & money: Do you need to borrow money to improve your home or make it a green home by installing green appliances? The savings which you accumulate could pay for the cost that you borrowed.
- Investment which boosts future earnings: The more educated a person is, the better will be his earning power in the near future. Taking out an educational loan is considered as a wise option. Student loan is just a mere invest in your future.
All the other sorts of debt which we incur on our credit cards, personal loans, payday loans are considered as bad debt. It is imperative that we quickly take action against bad debt so that we can increase our future income.
Secret tips to reduce bad debt and shape your financial future
Businesses which work only on cash won’t ever require worrying about incurring bad debt but this scenario is pretty uncommon in our country. Most businesses and individuals end up racking bad debt and this is what restricts their growth. If you too are going through such a situation, here are some ways in which you can eliminate bad debt and boost your income.
- Analyze and cross-check credit policies: Unless you take note of it, accounts receivables can soon creep up on you as it ages with time. You should make it a point to review those every month and check which customers pay on time and which are not. The longer a receivable remains unpaid, the higher will be the probability that it may not be paid. Put few customers on cash-only basis when they start paying late.
- Let go of all terms: Put an end to offering payment terms to your customers and prevent your customers from putting your bill at a side. Payment terms usually let your customer pay in either 30, 60 or 90 days rather than making them pay during delivery of product or service. Unless you have enough faith on the customer, it is better to take payment right away to boost your income.
- Discount on cash: You can instead offer a discount to your customers when they pay you cash immediately after buying the product. In case you accept credit cards, you’re then not allowed to offer cash discount. This can be an attractive offer as customers would then pay you immediately in order to leverage the discount of paying with cash.
- Collection agency: We are not new to the unsavoury reputation that the collection agencies have earned. You may sometimes need to assign few bad debt accounts to collection agencies so that they can carry on with the collections. When you give up the account, you will own the debt and the collection agency automatically receives a portion of the commission for whatever they collect. You can even sell bad debt and ask them to keep whatever they collect.
- Policy of debt collection: You need to establish a certain policy for debt collection of your business. You have design a few actions and letters which your company will take for those customers who have a habit of paying late. In case the customer is 30 days late on some product, send him a polite letter reminding him of his debt. When the account gets 60 days late, send a stronger letter than the previous one probably informing him that just as you value your customers, they should also value your business. Such steps will gradually force them to pay you on time. If nothing works, turning over to collection agency will be appropriate.
Questions to ask yourself for avoiding bad debt
Whenever you borrow funds, ask yourself these questions. If the answer is ‘No’, the debt is probably bad for you.
- Will this money enhance my finances in the near future?
- Did I shop around to attain the best deal?
- Can I cope with a sudden rise in interest rate?
- Did I check whether or not I’m borrowing at the best competitive rate?
- Can I comfortably repay the monthly instalments?
- Do I understand the terms and conditions?
Therefore, after going through this article, you must have understood that bad debt can be harmful for your individual and commercial finances. Take every required step to avoid incurring bad debt and repay them to get back a firm grip on your finances.