Making Money Work for You: A Guide to Identifying Good Loans and Avoiding Bad Ones

Feeling lost in the maze of loans? Wondering if that tempting offer is a golden opportunity or a potential money trap? Debt often carries a negative connotation, but it's essential not to judge it solely by its reputation. While the risks are evident, exploring the flip side of the coin reveals debt as a potent tool that can propel you closer to your goals. Debt can have positive or negative implications, largely based on its purpose. Typically, debt utilised to enhance wealth or bolster one's financial position is deemed as good debt. Conversely, financial burdens that are unsustainable or lack lasting advantages may be categorised as bad debt.

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How do you classify debt as a good or bad?

The good news is that there's a simple method to differentiate between potentially "good" debt and "bad" debt. By evaluating the purpose and potential outcomes of borrowing, you can determine whether the debt will ultimately contribute positively to your financial situation or hinder your progress.

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While some forms of debt can be concerning and burden your financial future, others can serve as investments in your long-term financial security. It's essential to differentiate between the two and prioritise managing debt that contributes positively to your financial well-being while being cautious of debt that may hinder your financial goals. 

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Here’s an Illustration of how a good loan will help you generate wealth

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Suppose your goal is to buy a house of 1 cr by availing a loan of 80% from the bank. The loan tenure is assumed to be 20 years at 8% interest p.a. Capital appreciation of the house purchased is assumed at 6% p.a. 

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Below chart shows how the value of Home equity will grow over the years leading to wealth generation for you.

Home Equity = Fair Market value of house - loan outstanding

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Availing a good home loan offers key benefits. It makes homeownership feasible without upfront payment, enabling wealth accumulation through property appreciation. Additionally, tax deductions reduce liabilities. Homeownership ensures stability, eliminates rent expenses, and improves the credit score for future financial opportunities.

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Remember, credit essentially entails borrowing from your future self to purchase something in the present. Therefore, it's logical to avoid borrowing money from your future self for purchases that won't enhance your future self's capacity to repay that debt when it becomes due. By understanding the distinction and making informed decisions, you can pave the way for a more financially secure future.

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