A very small percentage of people feel bad taking debt,
however, many people find difficulties when it comes to paying debt.
Many a times, people find it challenging to pay debts
because they took bad debts. When you take a good debt, there are high chances
that you will not have any difficulties or second thoughts in paying the debt.
In this article, I will be shading light on what encompasses
good and bad debt. I believe that understanding the difference between the two
kinds of debt is crucial especially making financial decisions that will impact
your long-term financial stability.
In Kenya, the debt burden is overwhelming and there has been
constant conflict between settling the country’s debt and maintaining the cost
of living among the common citizens.
According to the central bank of Kenya (CBK) household debt
has been on a steady rise as many families are depending on loans to meet their
basic needs.
There is a simple way of knowing whether a debt is good or
bad. Just ask yourself, what’s the impact of this debt to my net worth and
future value? If a debt has a positive impact to your net value and heightens
your value, then it’s considered a good debt. On the other hand, when a debt
drains your net worth and over time its value is not seen, then it’s a bad
debt. Let me give an example, when you take a debt to pay for education or
start a well-researched business, then such a debt can be categorized under a
good debt. Contrarily, when you take a debt to buy a car or go on a vacation,
there is no financial value that such a debt brings to you. As a result, such a
debt can be considered as a bad debt.
The first thing when evaluating your debt situation will be
to consider looking at your debt-to-income ratio. It is the summation of all
your monthly debt payments divided by your gross monthly income. For example,
if your monthly mortgage is Ksh 15,000, your car payment is Ksh 10,000, and you
are paying Ksh 5,000 for credit cards and other bills, then your total debt per
month is Ksh 30,000. If your gross income is Ksh 60,000 a month, then you have
a debt-to-income ratio of 50%. Anything above 43% raises a red flag with probable
lenders, meaning one might not be able to service the debt comfortably every
month.
Home ownership is considered one of the cornerstones of
financial security in Kenya. Real estate, especially within towns such as
Nairobi, Mombasa, and Kisumu, has appreciated several-fold in recent times.
Buying property gives one a place to stay and allows building equity over some
time. It may be a smart financial move to invest in real estate since property
values in Kenya always appreciate, ensuring high returns in the future.
Education is the most powerful tool in augmenting earning
ability. In Kenya, going for a loan to pursue higher education may be good debt
if it opens up any high remuneration opportunities. For example, pursuing
degrees in such high-demand fields as engineering, medicine, and information
technology can yield substantial returns on investment. HELB makes learning
more accessible through relatively cheap loans to students.
Entrepreneurship can contribute significantly to boosting
the economy of Kenya. SMEs account for a huge percentage both in terms of
employment and GDP in the country. A business loan will help one raise capital
for starting up or expanding a business. However, a good business plan and
viability should be ensured not to fall into bad debt.
Though credit cards may be convenient, they can turn into
bad debt within a snap of a finger. When high-interest rates are added up over
time, they can raise your debt slowly, eventually making it very difficult to
pay. One should be wise in using their credit cards; therefore, always settle
the full balance each month to avoid interest charges and maintain a healthy
credit score.
The reality of mobile loans in Kenya, provided through
services such as M-Shwari, KCB M-Pesa, and Tala, among others, gives one access
to fast cash. In most cases, the interest charged on these loans is high with a
short period for repayment, which if not well managed leads one to a vicious
cycle of debt. One is advised to only use mobile loans when in emergency cases
and find other ways of financing bigger expenses.
Even though owning a car may be a necessity, as in the case
of urban areas wherein public transport is limited, an automobile is, by
nature, a depreciating asset. Unless the car is literally essential to making a
living, financing it usually is bad debt. The most financially prudent choice
would be a reliable and affordable vehicle.
Properly understanding what distinguishes good debt from bad
is an extremely basic tenet to secure financial decision-making in Kenya. While
good debt enhances your net worth and eventually works to secure your long-term
financial situation, bad debt holds you back from making financial progress.
Looking at the ways debt will impact your financial position and the borrowing
decisions that will make for a difference, it becomes easy to navigate through
all troubled waters of debt into a more secure financial future.
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