Unpacking the Definition of Debt

Debt is a word that we hear often and is used by financial practitioners on many occasions. Simply put, it refers to a financial obligation for one party, the debtor, to repay the money owed to the creditor per an agreed-upon arrangement. The benefit for the creditor is that they charge interest on the funds, meaning that the debtor ends up paying much more than they initially received. Debt is essentially the deferment of an immediate payment and allows one to enjoy the benefits and merely repay the funds in instalments. Debt is not a foreign concept, in fact, people at all levels make use of debt financing to achieve certain goals and meet deliverables. Individuals, businesses and even governments have all enlisted debt financing, of course the amount is relatively less for individuals than it is for governments.

The most common examples of debt for individuals include credit card debt, car loans and mortgage bonds. Credit card debt is one that many people fall into blindly by spending money that they do not have. They end up accumulating useless debt from purchasing clothes, food or prioritising living expenses that could have been avoided. A car loan and mortgage bond, on the other hand, are the two types of debt that the majority of working people willingly take on because they believe they are worthwhile and provide convenience. For businesses, debt is often part of their overall finance strategy. Most start-up and expansion efforts make use of debt financing in the hopes of making enough profits from subsequent operations to repay it timeously. Similarly, governments take on debt for a similar reason, usually to finance major projects and for ongoing expenses of citizens and running a country. It is also a way to establish relations with other countries which may be mutually beneficial. These relations with other countries also provide an opportunity to get a better understanding of how various countries and economies are performing, which impacts forex and your investments in those countries, if any.

Good debt versus bad debt

Some people are of the belief that there is no such thing as good debt, as any form of debt is money at your disposal that must be paid back with interest. However, when one considers the purpose of the debt, that notion can be debated. Good debt is money owed that will be used for things that can help build wealth or increase income over time. Bad debt, on the other hand, applies to consumer debt that will do very little to help you achieve financial freedom or improve your financial standing. Some examples of bad debt include loan shark financing, credit card debt, payday loans and personal loans with no real purpose, amongst others. Some examples of good debt include student loans, mortgage loans, business expansion debt and real estate investments. It is quite clear to see that the good debt examples are generally aimed at making money in the long-term, while the bad debt examples are generally for immediate and short-lived gratification.