Personal Finance

Debt

Good Debt, Bad Debt?

People don't like debt, but there are few people live without debt nowadays. Your mortage on the house, your car loan, your credit card payments, these are all different forms of debt. The good news is that not all debts are bad thing, only the bad debt is bad for you.

Good debt means the money you borrow to go up in value or increase the earning potential for you, such as the loan you borrowed to purchase a mutual fund, money you borrowed to pay for tuition towards a degree. These debts will not only benefit you in the long run financially, the interest payments on some of these loans are also tax deductible.

Bad debt is the debt you incurred without bringing you any financial return, and quickly deline in value, for example, a vacation, clothing, expensive meals etc.

	Good or Bad debt?	Interest rates tax deductible?
Borrow to make investment	Good	Yes
Borrow a student loan	Good	Yes (depends on program)
Borrow to contribute to RRSP	Good	No
Borrow to renovate your house	Good	No
Borrow to renovate your rental house	Good	Yes (deduct your rental income)
Borrow a mortage	Good	No
Borrow a car loan	Bad	No
Borrow to pay for personal expense	Bad	No
Borrow on credit card	Bad	No
Borrow on Personal line of credit	depends	N/A

Debt Service Raio
How much you should borrow? The generally accepted guideline is to limit your debt-to-income ratio below 30-35%.
There are two popular debt service ratios: GDS ratio and TDS ratio.

GDS (Gross Debt Service ratio) = (annual mortgage payments + property taxes) / (gross family income) (less than 30%)
TDS (Total Debt Service ratio) = (mortgage payments + property taxes + other debt payments) / (gross family income) (less than 40%)

Your Monthly Income	Your Monthly debt payment (at 35% ratio) (including rent or mortgage, auto loans, minimum credit card payments etc.)
$1500	$525
3000	1050
4000	1400
5000	1750
6000	2100
7000	2450
8000	2800
10000	3500

Worry Signs to watch for your debt:

Your have reached or exceeded your credit card limits.
You can only afford to pay the minimum payments on your credit card.
Your cannot pay all your monthly bills, and have to borrow from your credit card.
Your have to purchase on your credit card for the stuff you used to pay for with cash.
Your start to borrow money from your family or friends.
You have no money for emergency purposes.

Pay off your bad debt

Consolidate your debt to negotiate a lower-interest loan, and increase your cash flow;
Prioritze your debts by paying off non-interest deductible, high-interest payments debts.
Debt pay-off sequence: High interest credit card loan --- Lower interest credit card loan --- Car loan --- Bank loan --- Mortgage.
Sell off your assets to repay some of your debt;
Cut out on your luxury spending;
Get rid of extra credit cards;
Reduce your expense and increase your income

Bankruptcy & Alternatives
As a general rule, bankruptcy should be your last resort because it's difficult to re-establish your credit, and bankruptcy will stay with you for at least seven years.