You might think what’s the big deal, they are just money. Obviously, money! but has some differences between them.
Credit and debt are both the common terms we use, which basically has a different meaning but are the two sides of a coin when it comes to personal finance.
Credit and Debt
Credit gives you buying power, which is a good thing, and on the other hand, it brings you debt as well. For example, Let’s assume that you get a loan amount of 1M Rupees to start a business. The loan amount is credit and it helps you to buy a thing which you are not able to because it is not affordable, I mean Since you don’t have enough money you are borrowing it from the bank.
Since you must repay it in some time in the future, you are creating debt. Today you get to spend 1M rupees(credit) at the same time you must repay it in the future(debt), so that’s they are two sides of a coin if you get credit, you are creating debt simultaneously.
Since credit creates both spending power and debt, It is important to clearly understand the intent behind taking credit. After all, if the credit is used productively enough to generate sufficient income to service the debt you are not going to face the problem, and neither the lender.
This brings us to the topic of
Good debt and Bad debt
Basically, the idea of taking a debt doesn’t have positive emotions on people because debt can be both helpful and a huge burden. It depends on the purpose.
Good debt is something like the previous example i.e, Getting a loan to start a business. It is good debt because you can repay the loan with the profits from the business, The debt helps you to build wealth. Good debt can be considered as an investment.
On the other hand, Bad debt take more money out of your pocket. Like if you get a loan to buy a car, it is not going to make you any money, and in fact, it is going to cost you( maintenance cost). Buying a car is not a bad thing, just saying it as an example. Purchasing something that losses its value in the long run and with a high-interest rate is bad debt and bad investment.
“If you can’t afford it and you don’t need it, don’t buy it”
Money and credit
Isn’t money and credit are same? the answer is No. Money and credit are the most misunderstood terms. They are money but two different forms. Sounds confusing? I got you.
Aha! money, everyone loves it. Currency, it is a tool or a medium of exchange to buy goods and services. RBI issues the currency notes in India, You own it, You have it in your wallet and use it to buy goods and so does the others, which helps the economy move forward. You must work or do business to earn money so, you cannot make money out of thin air. Remember hearing “money doesn’t grow on trees”?
But you can create Credit out of thin air. Credit is the borrowed money i.e someone has lent you that money in most cases it will be banks and credit does not come as free, you must repay it with some extra amount(interest). When borrowers promise to repay the money and lenders believe them, credit is created. Made out of thin air right?
That’s how it works with credit cards too. When you withdraw money(credit) to purchase something, you owe the bank i.e, you are borrowing and you have to pay it back.
so when you buy a product using a credit card the final price of the product will be product price+intrest.
This is not the case with debit cards. They deduct money directly from your bank account, which has the money you own.
So, next time when you buy something I hope that you will remember if you are buying it using credit or money.
Originally published at https://www.walth.org on October 18, 2020.
