- Bad debt is borrowing that decreases your net worth.
- If you or your business is in trouble, merely throwing more money at the problem will rarely solve the issue.
- From a lender’s perspective, good debt is debt that gets paid.
Most people think of debt as bad, something to be avoided. But, debt can be good or bad, for both lenders and borrowers.
For someone borrowing, good debt is debt that leads to increases in your net worth. This can happen in a variety of ways. Debt can finance new investments in equipment, software, or people that enable you to save time to focus on other opportunities. Student loans finance an education that can lead to higher earnings. Home improvement loans that will increase the value of your house and the quality of your life. Debt that helps you manage your finances, such as a consolidation loan, can also be considered good debt. It’s also good to just have some debt and pay it off timely, so you improve your credit score. This will help you be able to borrow when a future opportunity to take on good debt arises.
Bad debt is borrowing that decreases your net worth. New car loans are perhaps the biggest example of bad debt. According to some estimates, cars lose 10% of their value within the first month of ownership.If you cannot pay cash for a car, take out as small a loan as possible. Bad debt includes credit cards and other loans with high-interest rates or fees. Some alternative finance companies have products with an implied interest rate of 50% to 150% per year. That debt iscostly and would be considered “badidea” debt.
Any loans that involve “throwing good money after bad” are also bad debt. If you or your business is in trouble, merely throwing more money at the problem will rarely solve the issue.
If you own a business, you might not consider yourself a lender. But, if you perform services or provide products for someone before receiving complete payment, you have loaned them money.
From a lender’s perspective, good debt is debt that gets paid. Researching your customers increases your chances of being paid. I have frequently worked with clients where simply calling the phone number for the “customer” made it clear that they had ‘loaned money’ to a sketchy business. I recommend that you ask any new customers to fill out a credit application. The information you find on the credit application can help you decide if the client can pay their bills. If not, you may wish to decline the business or request payment upfront.
Just as establishing a credit history with debt can help you, a loan that creates a stronger relationship with a good customer can also help your business. After all, people run businesses. People tend to remember those who helped them at the beginning or in a difficult time.
Unpaid debts are bad debts. Once an invoice is 90 days past due, industry statistics show there is already a 27% chance it will never get paid. That increases to 50% when the bill is seven months past due.
It’s important to stay in contact with your clients and spot the signs that trouble is coming. Warning signs of bad debt include:
- Lack of communication/ignoring calls or emails
- Staff changes
- Unprofessional excuses for late bill payment
- Sudden change in business plan
- New competitors
- Frequent requests to serve as a credit reference
In many ways, our economic system requires debt. Knowing which debts make sense for you and your business will help keep you out of trouble.
This article was written by Dean Kaplan, president of The Kaplan Group, a commercial collection agency specializing in large claims and international transactions. He has 35 years of manufacturing, international business leadership and customer service experience. Today, he provides business planning, training and consultation to a variety of global companies.