Money9 Helpline | How to identify between good and bad loans?

While one would often like to aim for a completely debt-free life, it may not always be the case. Taking a loan is often the only way for people to afford an important, big-ticket purchase like a home or a car. Sometimes, taking a loan is the only way out of a financial emergency as well. But do you spend enough time to know whether you’re availing of a good loan or a bad loan?

The repaying capacity against any loan usually indicates how good or bad it is. Let us understand what makes a loan ‘good’ or ‘bad’?

Good loan 

Any debt is considered a ‘good loan’ if it has the ability to generate assets over time and the product value doesn’t deteriorate with time. Education and home loans are classic examples of good loans.

While an education loan supports your academic endeavors and helps you become financially independent, the principal home loan amount can be utilized for tax benefits and the asset value only increase with time.

Bad loan

Debt availed solely for the purpose of buying luxury items is considered to be ‘bad loans’. This can include credit cards, personal loans, and auto loans.

Interest charged on credit cards and personal loans is usually very high. They should be opted only in case of real urgency otherwise, with inconsistent repayment capacity, your credit score can be impacted.

Common queries

In a recent episode of Money9 Helpline, callers inquired about a checklist to identify good and bad loans.

“You need to assess your affordability. Always notice how much will a particular loan stretch your expense and income ratio. Another parameter is interest rates. How much is the interest rate being charged against the loan. For example, for home loans, the rates of interest are comparatively on the lower side, whereas for credit cards the interest rates are exorbitant. So you need to evaluate how affordable and necessary the loan is for your financial life,”  Viral Bhatt of Money Mantra said.

“My monthly income is Rs 50,000 and my monthly expenses are Rs 15,000-20,000. I want to buy a car. How much loan should I avail keeping my income in mind?” Ashish Gupta, a caller from Mathura asked.

Bhatt suggested that one should go for a car loan only if it is a necessity, “If you really need to buy a car, only then should you avail a loan. For the loan, you can shell out 30% to 40% of your income, after considering your expenses and affordability.”