Debt: Bad or Worse?
For the past 3 decades (at least) YOU have been told by us (media) that there is ‘good’ debt and that there is ‘bad’ debt.
Good debt is a beautiful concept ‘created’ by lenders with a great, benevolent image to say that:
interest rates are low
it is tax deductible and
it is used to fund an asset that will always appreciate.
Bad debt on the other hand is:
you take it because you want to live beyond your ability to pay cash (the world accepts that cars can only be bought on installments),
interest rates are high, but that is ok. Banks have to earn, do they not?
it is not tax deductible, but it allows you to enjoy life NOW and pay for it later
Typical examples in the first section is of course a HOUSING loan – sold to you saying that if you borrow at 10% p.a. and buy a house, the house will ALWAYS appreciate at 14% p.a. so your Wealth will always go up. Awesome story.
Then there is the education loan. Take a loan of Rs. 10,00,000 do an MBA and get a Rs. 12,00,000 job. Awesome return on investment.
The next category is of course car loan, wedding loan, cricket match abroad loan, divorce loan, – largely any reason as long as the banker is sure he will get back his loan amount. It is a Form 16 loan, based on your ability to repay ….
The truth is there are only 2 types of loans:
Bad loans and Worse loans.
All loans are bad. If they have tax deduction, that acts as a ‘malam’ that is all.
Period.
Muthu
Superb. Iām extremely debt averse and am able to connect to what you say. Whether it is my clients or friends; I strongly encourage them to clear the debts, not get into new ones and above all consciously spend significantly lesser than their means.
Srinivas
Interesting insight.
However, an instrument is inherently not either good or bad. It all depends on how it is used. Sweeping arguments like good or bad, may not show the full picture/potential.
I give my example. I took a loan to buy a (second) house. On the interest payement, i got full tax breaks. Now after 4.5 years, i completely paid off the loan and planning to dispose off after 5 years. This process(of buying a house on loan) made me more diligent saver. In addition, i will be left with tax free amount for the capital initially employed with indexation.
I would like to conclude that a financial instrument is like any other instrument. Can cut either way, if the user doesnot know how to use it to his advantage.
Jayant
Could not agree more!
Srinivas Muthadi
“The truth is there are only 2 types of loans:
Bad loans and Worse loans.”
Summarizes everything. Thanks for another nice thought provoking blog.
Mira D
thanks. this year I will payoff my tiny home loan.
Rajeev
PPF investment is a good debt.
A housing loan taken to build your first home is also a good debt.
No doubt you pay the price.
Having no debt is a luxury we can not enjoy in the early years of life.
Regards
param
excellent! i’m glad someone else also thinks that the tax deduction does not justify taking a home loan š
subra
A sword or a gun do not kill. The jerk holding it does.
Derivatives DO not hurt. The uneducated person using it brings a company down. Ask Barings, and now JPM.
Incurring an expense because it is tax deductible is as stupid as telling your boss ‘please reduce my salary, I do not like the 30% tax in India.
80C is atleast somewhat sensible….sec 24 is just a stupid client fooling device introduced by the Housing Finance Industry..
Nitin
Subra,
How about this… (this example is valid for United States of A :D)
if i take car loan say at 1.5 % (yes its true and you can get for excellent Credit history) say 10K for 60 months even you have 10K available. Invest that much money for Index fund for 5 years or some Debt product outside USA..cant we get more than 1.5% after Tax? I think it depend upon case to case what is good and what is bad.. we cant generalized.
Appreciate you view on this.
Mrhdk
Agree with Srinivas. Loans can be used judiciously to maximize the returns.
I have my own experiences on either side of loans.
I generated significant cash flow in 2003 and used 1/3 of it to fiully pay off my housing loan and put the remaining 2/3 in equity mutual funds.
When I look back at that decision, I can only repent. All those equity MF investments have become 5 times. If I had not repaid the loan and put all the money in equity markets, I could have bought a 1 BHK flat in Mumbai suburbs just from the differential gains.
However, it would have happened because of 2003-08 rally.
As long as you can generate returns more than your interest costs, one should not be averse to loans.
param
“As long as you can generate returns more than your interest costs” – this is they key – and there is no way to predict…
just a thought, if banks/FIs know this secret, why are they lending us money instead of investing in market or houses themselves???
subra
that exactly is the problem param. People take one example in their lives and say “it always happens like this”. Look at the example saying ‘I bought an asset in 2003 and that property doubled by 2008’. To me it sounds like a joke..because I can give a list of shares in MY portfolio which went up 10 times. This was the golden period when the sensex went from 3k to 21k. It is also the time when the Cap goods index went up 20 times. I had invested in Tata Power, LnT…etc. what do I tell the guy who doubled his money? LOL. Realising that this was the ‘Slumdog Millionaire effect’ is important, OR you will get lynched.
Praveen
I don’t know about the future but atleast here in Bangalore if I had bought a 2 BHK in 2004, now the EMI I had to pay will be less then the rent I had to pay for the same flat!!!
subra
Brilliant. If I had bought a flat for Rs. 20L in 2004, and rented it out at Rs. 12000 a month…now the flat would be worth Rs. 50L, I would be getting Rs. 28000 as rent….and I would have been happy.
If I had bought a ….for Rs. 2000L in 2004, and….for Rs. 12L a month, ….correct?
realise the folly? LOL
bharat shah
i consider, this post is about ‘absolute debt’ i.e. taken in anticipation of future income , sometimes excessively thought of, out of thinking the real estate prices would ever be increasing or we missed syndrome. and that could be’ bad ‘ or ‘worse’,as it would be most probably with mental stress. what some talked , is not ‘debt’, but is ‘hedge’ and may be ,at the most, a little loss or considerable loss, but not mental stress.personally i think, ‘debt’ for buying a house, should be avoided ,or to be kept a bare minimum.
Vikas
Subra,
I do not agree with ‘All Loan’ as even for economy to walk forget run they need to produce products, and for that every producer can not have all the money all the time. here they have to go to banks etc for this financial help (loan) and with this help they produce.
Same instance apply to individual who take this help many times in the situation thwy have not planned and to takcle that this help is mendatory.
Rajesh
Well,Well.. I can accept for MOST of it..
But taking a loan for a good education is worth much more than what your mind can comprehend.
I know of several cases where the student was exposed to multitude of opportunities he could never dreamt of…
Loans are excellent products to use wisely unless you are born with a silver spoon..
You mean an entrepreuner taking a debt for setting up/scaling up his business is an idiot?.. Well, congrats I can say!!! š
your conclusions abt debt are blanket statementss at uts debt
Rajesh
“your conclusions abt debt are blanket statementss at its best!!”
Payal
Awesome sense of humour. I come to your site more because apart from gaining knowledge, it manages to tickle my funny bones.
With a house becoming so unaffordable in Bombay, the only loan that is inevitable is home loan. “Watching match abroad loan” is a no-no, I want to slap the person who ever took this loan š