Part 3 of 3-Part Series
This brings us back to good debt and bad debt, and why if used properly, they are an invaluable tool for business and individuals. When debt, or more commonly known as loans, are taken out, if it used to purchase or invest in an asset which will appreciate in value, it is a good debt. Of course, that is an oversimplification since the amount of money to be made and the time it takes needs to be factored in. But very generally, this is a sort of rule to follow. If the debt is used to pay for a depreciating asset, think a car or boat, it is not a good debt because you will lose money on the deal. However, again there is more to it! Perhaps you need a car to get to work, but can’t afford to pay for it in full. In this case, you take your income into consideration and the fact you need transportation to make it and it comes a good debt. Another factor to consider even if you do have all the money on hand to pay off your car is whether that will leave you cash strapped and unable to use the money for other necessities. A debt agreement could be very beneficial here as well.
As you can see, the discussion of debt is not a black and white one because there are many variables to consider. It is also why we use a debt ratio in your financial advising, because it is a necessity in nearly everyone’s financial journey.
It is a very simple ratio, taking the total amount of all of your debt over the year and dividing it by your personal income over the year. There are very specific levels of debt which are considered healthy and generate returns and these are the values it is best to reside within. As with all parts of your financial life, the debt ratio is used in conjunction with our ratios in order to take into account everything possible before making financial decisions.