Let’s face it—nobody likes being in debt. It feels scary because it means owing money and being tied to obligations. But let’s be real: most of us will encounter debt at some point in our lives. After all, how many people can afford to buy a house or car with cash these days? I’m here to tell you that not all debt is necessarily bad. Surprised? Hear me out. Minimising debt is important, but there is a difference between good debt and bad debt. Good debt can offer you long-term financial benefits, while bad debt can harm your finances. In this article, I’ll help you understand what good debts and bad debts are, along with some examples. Let’s dive in!
Is there such a thing as good debt?
Short answer: yes. Although having debt is not exactly everyone’s first choice, I would argue that certain types of debt can offer you significant returns in the future.
What is a good debt?
Good debt is something that helps you improve your financial health over time. It is often associated with investments that have the potential to appreciate or generate income. The main characteristic of good debt is that it’s used for a purpose that will provide you with long-term value or benefits. In Malaysia, several types of debt are generally considered good and can help improve your financial health over time:
1. Home loans (mortgage)
A mortgage loan can be considered good debt in Malaysia due to its potential for asset appreciation, income generation, low-interest rates, and the ability to build equity over time.
For example, let’s say a homebuyer in KL pays RM1,500 monthly for their mortgage. If they rent out the property for RM2,000 a month, they’ll make a profit of RM500. So, even if the market is slow, first-time homeowners can explore house-sharing with tenants to help cover the mortgage. This will not only help reduce the mortgage burden but also save on what would have been spent on renting another place.
While it is essential to manage your mortgage debt responsibly, it can also be a valuable investment tool for your long-term financial growth.
2. Student Loans
Taking a student loan to further your studies is considered good debt. In general, having a better education increases your chances of being hired for a better career and earning a higher salary. According to the Khazanah Research Institute, the median salary for tertiary-educated employees (including both diploma and degree holders) was RM3,794, compared to RM1,797 for those with only secondary education.
In Malaysia, PTPTN loans are designed to help students from lower-income families repay their loans over a longer period of time. They provide borrowers with a flat interest rate of 1%, which is significantly lower compared to conventional bank loans.
For example, if a student borrows RM50,000 for a repayment period of 15 years, the total interest paid would amount to RM7,500, resulting in a monthly repayment of approximately RM319.44. This way, children from B40 or M40 families stand a chance of becoming more educated and finding better-paying jobs without the burden of immediate loan repayment.
3. Business Loans
Borrowing money to start or expand a business in Malaysia can be considered good debt if the venture is successful. One benefit of business loans is they provide you with the necessary capital to fund operations, purchase inventory, or invest in equipment—all important for growth.
Unlike equity financing, taking a loan does not require giving up ownership or control of the business, which allows entrepreneurs to retain full authority over their ventures. They can also serve as a financial safety net, providing funds during unforeseen circumstances or downturns. So, if your business generates income and grows in value, the debt will be worth it.
4. Car Loans
While a car may lose value over time, taking out a loan to secure transportation for yourself is still considered good debt. Having a car is essential for mobility; it makes it easier to commute to work, run errands, and access a broader range of employment opportunities.
Additionally, successfully managing your car loan can help build your credit score. Car loans often come with competitive interest rates and flexible repayment terms, allowing borrowers to finance a vehicle without straining their finances.
What is bad debt?
Bad debt is debt that can negatively impact your financial health. It often involves:
High interest rates, usually over 6%
Excessive borrowing compared to your income or credit limit
Purchases that do not appreciate in value or generate future income
In other words, bad debt is money borrowed to finance things that lose value quickly, like clothes, luxury cars, vacations, boats, and most consumer goods. It also includes debt that becomes too large to repay comfortably.
1. Credit Card Debt
Credit cards are a popular financial tool, but they can easily lead to bad debt if not managed properly. Credit cards often have high interest rates, sometimes over 20%. Many individuals in Malaysia are struggling with credit card debt; as of June 2024, we have a credit card debt of RM3.74 billion!
The convenience of credit cards can lead to overspending due to impulsive purchases, resulting in debt that exceeds your ability to repay.
If you carry a balance from month to month, the interest can accumulate quickly. Carrying a large balance can be costly and hurt your credit score. High credit utilisation (the ratio of your credit card balances to credit limits) can negatively affect your credit score, making it harder to secure loans in the future.
(Find out how to make your credit card work for you.)
2. Payday Loans
Payday loans are short-term, high-interest loans designed to cover urgent expenses until the borrower receives their next paycheque.
These loans often come with interest rates that can exceed 400% annually, making them one of the most expensive forms of borrowing. Borrowers may find themselves stuck in a cycle of debt by taking out new loans to pay off old ones.
3. Gambling Debt
Engaging in gambling can lead to substantial financial losses and personal hardship. It is estimated that Malaysians lose around RM3 billion annually to gambling activities, with a significant portion of that amount leading to debt.
Unsecured personal loans without collateral can be risky, especially if the borrower struggles to make repayments. Beyond financial implications, gambling debt can lead to emotional distress, relationship issues, and social isolation. In some cases, individuals may resort to illegal means to cover their gambling debts, leading to legal troubles.
Tips for Managing Debt Effectively:
Create a Budget: Track your income and expenses to understand your financial situation and identify areas where you can reduce spending.
Prioritise Repayments: Focus on paying off high-interest debt first to minimise interest charges.
Avoid Excessive Borrowing: Only borrow what you can afford to repay and avoid taking on multiple loans at once.
Seek Professional Help: If you're struggling to manage your debt, consider consulting with a financial advisor or credit counsellor.
(Learn how to effectively pay off your debt!)
Conclusion
Understanding the difference between good and bad debt is a must in your financial journey. While good debt can be a valuable tool for achieving your financial goals, it's important to balance it with responsible borrowing habits. Although certain debt is considered good, having excessive debt will still create financial strain and limit your ability to handle unexpected expenses. So as always, please do your own research before making any financial decisions.
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