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How to make debt work in your favour?

In a country where having a discussion about Money is taboo, the situation of a healthy discussion for Liabilities is far worse. We do not see a group of friends having a conversation about liabilities and debt, it is just like a personal thing. It is “not meant” for discussion. Even the discussion of money or personal finance as a topic is rare between close friends. Maybe because the topic is known to all and is not required to be discussed or maybe there is no encouragement or knowledge of Finance. We all know the reason and let me tell you it is not the latter one.

A few weeks ago we discussed that how Liability just as a word is frightening to a layman let alone the topic. We discussed how fear of it leads to more difficulties and we discussed two sorts of relations with one’s own liability which is Ignorance and Over Involvement. You can read the article here.


Good Liabilities vs Bad Liabilities

So, we left the past article at a point where I promised that we will have a look at Good Liabilities and Bad Liabilities and so, here I am. Ready to take you out of your Comfort Zone. For starters, the answer is simple Good Liabilities are Good for you and Bad Liabilities are Bad for you. If taken to good use, Debt can push your Financial Journey upwards or ahead for better results and that is Good Liabilities. And Liabilities that will act as a barrier or a dead weight and will pull you down or behind in your Financial Journey are Bad Liabilities. Let me make you see what I am trying to tell you.

See? How easy is that? No, it is not. It looks easy while you read it but when you face a real-life situation of dealing with your own liability, you will see it is not. Because Liability is Emotional. To heck with it, the whole topic of Money is emotional.

A person when deals with his/her/their own money thinks more from the heart than the brain.

The decisions or reactions are emotion-driven and not thought-driven. And that is when Liabilities become Good or Bad for you and in most cases it is bad.

So how do you actually recognize a Good or Bad? Whether the liability is good or bad is more person-specific and less rule-specific. But if a Liability, let us say a Personal loan is pricier (higher interest rate than other lenders in the market) then it is definitely a bad one and vice versa.


How can you use Debt for your Benefit?

Let us take examples. Credit Cards, for instance, Credit Cards are a boon to the household liquidity crisis. Credit Card helps an individual to postpone their expenses to a later date.

Let us see how is that possible. Let’s say Bhavana has a monthly income of Rs.50000 (on hand salary) and she also owns a credit card that has a credit limit (spending limit) of Rs. 30000 with a billing cycle of 30 days and payment of credit card due on 8th of every month. The monthly salary of Bhavana gets credited to her account on the 7th of every month. Bhavana makes payments of bills and purchases of monthly groceries and other necessities on the 9th of every month after her salary gets credited to her account. Bhavana has an average monthly household expenditure of Rs.28000. We will look at two situations, one with using a credit card and one without it.

Situation One (No Credit Card): Bhavana makes payment of her monthly expenditures from her bank account. After paying for her monthly expenditures, she has now Rs.22000 lying in her bank account. She will now have to make the rest of her variable or unaccounted expenditures from the 22000 that she has till her salary gets credited in her bank account on the 7th of the next month. So, Bhavana has now a liquidity of Rs.22000. Next month when her salary gets credited on the 7th she will have a total of Rs.72000 (22000+50000) in her bank account. And on 9th she makes another payment of Rs. 28000 for her fixed expenditure. So, on the 10th she will have Rs. 44000 (72000-28000) in her bank account.

Situation Two (Efficiently using Credit Card): Bhavana makes payment of her monthly expenditures from her credit card. After paying for her monthly expenditures, she has Rs.50000 (unchanged) lying in her bank account and another spending limit of Rs.2000 on her credit card. By using her credit card to pay for her fixed expenditures, she now has a liquidity of Rs. 50000 to deal with variable or unaccounted expenses till her salary gets credited in her bank account on the 7th of the next month. Now, next month when her salary gets credited she will have Rs.100000 lying in her bank account. But wait a minute, the credit card bill has to be paid. On the 8th of the month, she will pay her dues so as to attract no extra charges or Interest. She will pay her dues of Rs. 28000 so her credit gets restored for this month. And again she will pay her fixed monthly expenditure from her credit card. So, on the 10th she will have Rs.72000 (100000-28000) in her bank account.

See what happened here? By using her credit card efficiently, she increased her liquidity and postponed her actual expenses by 30 days. This gives her an extra money edge to fight an uncalled cash crisis whenever it arrives and this will save her from taking expensive personal loans at the moment when the crisis arrives. By using her Credit Card she can increase cash-on-hand and thus have extra liquidity.


What is Bad Debt?

This is how Liability can be put to good use to help you fight a liquidity crisis. Good Liabilities can actually help you increase your Net worth. While if we talk about Bad Liabilities, they decrease your Net worth substantially and put your financials under a lot of stress. It can be pricier loans, a huge amount of debt (debt which is more than the assets you own), and debt created for purchasing depreciating assets can be sometimes categorized as Bad Debt. Take, for instance, you take a Car Loan of Rs.5,00,000 at 10% p.a. for 5 years at around a Monthly EMI of Rs.10,500/-. The original value of Car is Rs.8,00,000. Now, if we calculate the total amount which you will end up paying for the car will be around Rs.9,30,000. And after fixed depreciation at 8% p.a. the value of your car will be around Rs.4,80,000/- A value difference of Rs.4,50,000/- And this is just the purchase expense.

Similarly taking the same example of Credit Cards, if you make purchases for your luxury needs using your Credit Card, the habit will soon transform into making unnecessary purchases and will lead you to a vicious circle of bad loans and thus affecting your finances badly.

To cut this confusion short, whether a Liability is Good or Bad will totally depend on your Net worth and your Finances. This article might provide a simple sight on how to classify whether a Liability is Good Or Bad, but to have a detailed insight on what impact this Liability will have on your Finance you need to consult a Financial Planner who will help you understand and will help you guide through this process. Remember, managing your Liabilities is as important as Managing your Investments for your Financial Growth. Financial Planning is not just limited to Investing but it includes everything that concerns your Finance. Consult a Financial Planner today for your betterment of your Financial Growth and start your Financial Journey right!

Till then, this is Shreyans Shah signing off. You Stay Safe, Stay Home and Keep Practicing Social Distancing.


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