If you already know the difference between having good debts versus bad debts, go ahead and skip this one. But for those that want to learn more about these 2 types of debts and my experiences about it, you may want to read on.
In this article, I’m going to be talking about debts in terms of business. If you’re not digging the idea of giving up a piece of your company or crowdfunding is too difficult for you to setup, taking out a loan to get your business on to the next level is a good risk to take as an option. People are usually afraid of the idea of taking out loans, and with good reason. But I’m here to help you make it more clear for you to decide on this one. There’s Good Debt and there is Bad Debt. I learned about bad debts the hard way as a fresh grad out of college, acquiring depreciating assets instead of investing in appreciating assets. Buying a sports car will be a great idea to take on bad debt. We’ll get to that later on. Calculating debt if it’s good or bad is HOW IT’S USED. Good debts produces return on investment or ROI, whereas bad debt is simply money spent without anything in value long term.
Example of bad debts are buying a nice car with money you don’t have yet (the interest and depreciating value of a car will eat up over time, buying the latest gadgets every time there is something new (upgrading your phones every 6 months to a year is bad idea), buying trendy clothes as often as every 1 to 3 months using debt is bad debt. With cars, it loses it’s value as soon as you drive it off the dealership premises, so in turn, your ROI is a sure negative. Your money isn’t no longer working for you, but against you. Unless you bought a car for let’s say Rental Business like taxi or Grab, then it’s a sure negative way to drain your money. My dad taught me this: “If for example you’re buying a 1M worth car, you need to have at least 2M sitting in your bank to purchase it. Otherwise, you’ll be spending so much time trying to pay that car off. The point of the car is to bring you from point a to point b safely and with comfort.”. JayZ said it best too, “If you can’t buy it thrice, you can’t afford it.”. So I highly discourage anybody from buying a 1M car if they only have 1M in the bank, more so if you only have less than half of it, as you’ll be stuck paying off the mortgage, paying interest, insurance, regular maintenance and miscellaneous fees. Buy something at least half of what you can afford.
But if you’re using debt to buy something with a higher rate of return, that’s good debt. That debt then will make you MONEY. For example, if you take out a loan to buy a house and you have it rented out of a profit, then that’s good debt working for you. The money you will make outweighs the interest that you are paying by at least 3-6x more.
Bank loans are you best resource for affordable debt. The biggest drawback is that getting approved can take months. Study the interests rates. If for example, your interest rate is 3% per month and the loan you will make will yield you 15% income, then you’re fine. Anything less than that is a disaster waiting to happen.
Let’s expound on it even more. If you’re going to borrow money for 20% interest because you’re going to use that money to buy inventory at Php 5,000 and sell it for Php 25,000, then you’ve now trades 20% interest rate for a 500% return. Now, that is a very good trade indeed, right?
Most entrepreneurs use what we can STRATEGIC DEBT in business where we can reliably predict the ROI. If we know that we are able to sell our inventory and get a 200% ROI on that singular purchase, then it makes sense to pay 10% interest or more on a loan. That will free up a lot of cash to use in other aspects of the business like for Marketing, Expansion, R&D and Manpower for example. It gives you more flexibility.
On a final note, I say there is nothing wrong with inheriting debts. All business people I know that are succeeding have debts with banks or lending companies, usually against their assets like buildings or homes as such. I would just caution anyone against using debt at the very beginning of an idea or at the early stages. Always remember this: Taking out a loan for an UNPROVEN CONCEPT is a fast track to financial disaster.
Always wait until you have predictable monthly sales to take out debt.
Question of the day: Do you have bad debts that you want to turn into good debts?