Perhaps you have heard about bad credit loans and how they can ruin the entire financial stability of a person. But have you ever tried to know what causes a bad credit score or compel a person to borrow a bad credit loan? Most people hardly know about it completely, and this is the main reason for borrowing bad debt unknowingly.
You may have started worrying that how can you discriminate between good debt and bad debt? Well, there are ample ways to judge whether you are borrowing good or bad debt. Moreover, it is very important to know it before borrowing.
Before we begin to state the differences, let us know the exact definition of these two types of debts.
What are Bad Debt and Good Debt?
Usually, common people used to borrow money for fulfilling main two purposes. When a person borrows money for investing into a plan, then it is known as good debt. On the other hand, whenever a person borrows money to manage finances or run a household, it is known as bad debt.
The only reason behind naming the first one as good debt is because the fund which the borrower has borrowed will be utilised for a good purpose. Generally, invested money provides the chance of getting a high return. So, it is quite certain that a borrower who borrows money for the purpose of investment will not lose any credit score. Rather, it will hike in due course.
On the other hand, borrowing money to manage finance or even due to financial crisis act is not at all constructive. Moreover, being financially unstable when a person borrows money, there is no assurance that he can repay the entire outstanding amount. As a result, if a person becomes a defaulter, then his credit score will also drop down.
Discriminatory factors between Bad Debt and Good Debt
From the very definition, it is not difficult to understand that both of them share good much discrimination. To avoid the wrong decision while borrowing money, you must be aware of these discriminatory factors.
| Point of comparison | Bad Debt | Good Debt |
| · Purpose of borrowing | When a person faces an extreme financial crisis, then he borrows bad debt for running his family. | A borrower used to apply for a loan due to investing money through a suitable investment plan. |
| · Chance of defaulting | Borrowers who apply bad debt have the highest chance of being a defaulter. The only reason behind this assumption is low liquidity. | On the contrary, borrowers who utilise the borrowed fund for investment have the lowest chance of being a defaulter. This is because they have enough money in their hand always. |
| · Nature of borrowing | Bad debt borrowers usually purchase daily household necessities and carry on other regular expenses. | People borrow loans just for investment as they do not like to lock in their liquid money for a long time. |
| · Credit score | Usually, bad debt owners do not have any good credit scores. Therefore, they hardly get monetary assistance from trustworthy financial intermediaries. | This type of borrower always possesses a very good credit score as they mostly borrow huge amounts of money for investment. So, for holding a very good credit score, most money lenders, especially direct lenders, used to offer the loan. |
Borrowing bad debt a good habit or not?
There is no doubt that when a person borrows bad debt, it never comes under the good habit. This is because,
- Bad credit increases the chance of multiple debts. Although the word may not seem very dangerous, it may actually create the upcoming financial crisis. When a person has multiple debts, then he has no other option without being a defaulter.
- Bad debt ruins the credit score. While a person possesses multiple unpaid outstanding debts in his name, all of them show in his credit report. Now increasing the number of unpaid debt will ultimately ruin the credit score.
- Whenever a person borrows money for managing finance, it does not come under any constructive financial requirement. Rather, the only purpose of borrowing money is to expense. Usually, after borrowing money through bad debt, one takes only a few days to use the entire fund. After a few days, the person again needs money to run a household.
- A borrower of bad debt needs to pay a high rate of interest. This is something completely unbearable. A high rate of interest clearly indicates repaying more than what he has borrowed. While everybody wants to minimise the repayment, at this point, a borrower needs to pay more than what he borrowed.
- Only small loans are sanctioned for bad debt owners. This is also a sorrowful incident. When one can’t borrow as much as he wants, then the chance of borrowing frequency becomes higher. So, people who borrow bad debts generally run within a cycle.
These are some horrible outcomes of borrowing bad debt. For this reason, we strongly advise not to step into the trap of bad debt. If you are ever trapped in such debt, it becomes harder to come out from that cycle. On the other hand, even during unemployment or financial instability, if you try to cope with expenditure by lowering family expenses, it will save you from bad debt.
Therefore, it is a kind of advice to you never to step into the trap of bad debt. Rather, when you have financial stability, try to apply for good debt.