Many of you may have watched that famous Hollywood film, The Good, The Bad, The Ugly.
One could also classify loans as good, bad or ugly. Since they have a significant impact on our financial and personal lives, both positive and negative, it's important to understand them better.
Here's a guide to help you avoid the debt trap, when taking a loan.
The good
Good loans like home loans are ones that build useful assets. The home is one of the basic necessities of life and everyone likes to own one.
And since they usually require a much higher investment as compared to one's income, taking a home loan becomes a must. But that's fine as we are acquiring something useful, and which will last us for a lifetime.
Not only do the home loans help us to acquire one of the basic needs, they are fairly inexpensive too. Today the interest rates are around 10-12 per cent pa.
Besides this, they have attractive tax benefits too. So, in all home loans work out as very 'good' loans. Education loans also join this category. They are inexpensive, very useful and come with tax benefits.
Similarly, vehicle loans also meet a very important need. They give a convenient means of transportation. Even though the interest rates are higher than home loans - around 12-15 per cent pa and there are no tax benefits, they still classify as good loans as they build useful assets.
The bad
Personal loans are bad loans. They are usually utilised to buy things like television, washing machine, computers etc, for your vacation abroad. So, from the 'need' perspective such loans are not essential like a home, education or vehicle loan.
Yes, most of these are assets, but relatively speaking, they do not require a very huge outlay. One could save some money for say 6-8 months and accumulate sufficient cash to buy these. Also, these loans are a bit expensive as compared to home/vehicle loans at around 15-20 per cent p.a.
Therefore, such loans are bad loans and preferably avoidable. Though, given the easy availability of such loans and increasing personal desires, it can be a fairly tough task to keep away from them.
The ugly
Credit card debts are the worst of the lot. They are the 'Ugly' loans and are very expensive. The typical interest rates on such debts could be around 24-36 per cent pa and maybe even more. This is simply too high a cost to pay.
Also, these loans usually finance consumption or luxuries, say a dinner at an expensive restaurant or a high-priced outfit. There is generally no asset built from these loans, and the payment continues for months to come.
These loans should be avoided at all costs. Except, maybe, when there is an emergency, you can use the credit card. But, thereafter all efforts must be made to clear off the amount at the earliest, even if you have to cut down on a few expenses for sometime.
Debt, especially the bad and the ugly one, has caused many disasters in the US and the same trend is being increasingly seen in India too.
The bad and ugly loans not only destroy financial lives, they play havoc with one's personal life and relationships too.
Therefore, prudent selection of debt will go a long way in building a financially secure and peaceful future.
The author, Sanjay Matai, is an investment advisor and promoter of wealtharchitects.in.
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