John leaned back in his chair, his phone buzzing with a text from the bank. Another loan offer? But after his last experience with a personal loan that quickly spiralled into a nightmare, he wasn’t so sure this time. Should he take it? Or should he walk away? The lines between good and bad debt are often blurry, but once we know how to spot the difference, we can turn debt into an ally instead of an enemy.
Debt doesn’t have to be represented as a bottleneck in our financial journey. It can be the hero—if we know how to use it right. So, how can we tell good debt from bad debt?
In this article, we will be exploring the concepts of good and bad debt, assessing debt worthiness in our ever-changing economic landscape, analysing the impact of inflation, and discovering how to use debt to create sustainable wealth.
What Is “Good” Debt?
The term good debt might sound like an oxymoron, but not all debt is created equal. Good debt helps us build wealth or improve our future financial standing. Think of it as a strategic tool for growth.
Examples of good debt in Nigeria include:
- Business Expansion Loans: Imagine you own a small business selling imported goods. A loan that helps you increase inventory during high-demand seasons could boost your profits and grow your business. That’s good debt—debt that works for you. By strategically using this loan, you're leveraging debt to create more income, which can cover the loan payments and boost your bottom line. It's not just borrowing—it's smart investing in the future of your business. That's the kind of debt that pays off!
- Student Loans: While just picking up in Nigeria, funding our education or skills acquisition can be considered a long-term investment. You might incur debt today, but if it increases your earning potential tomorrow, that’s a debt worth having.
- Agricultural Loans: Whether it's expanding operations, buying new machinery, or improving seeds, using debt to innovate in farming can greatly increase yields and profitability. You can invest in innovation that increases productivity and creates new market opportunities by carefully choosing which loans to take out. Given that, as of Q2 2024 (NBS,2024), agriculture accounted for 18.54% of Nigeria's GDP, this kind of debt can be used as a growth tool to convert borrowed funds into higher revenue and long-term sustainability.
In essence, good debt positions you to make more money in the future. It is strategic, planned, and backed by a strong purpose.
What Is “Bad” Debt?
Now, let’s talk about the flip side—bad debt. This type of debt is usually taken to finance immediate gratification or consumption, without any long-term benefits. It often comes with high-interest rates and unfavourable terms that trap you in a cycle of repayment, leaving you worse off financially.
Here are examples of bad debt:
- Consumer Loans: Taking out loans to buy the latest phone or gadgets is a classic example of bad debt. Sure, you’ll enjoy the product for a while, but it’s not adding any financial value to your future. Worse, you’ll pay a premium for the privilege.
- Informal Lending: Borrowing from friends, family, or local lenders without clear terms can lead to misunderstandings and unfavourable repayment plans. While these loans may feel more accessible, they often come with hidden costs—strained relationships, emotional pressure, and a lack of legal protection. To avoid these risks, always establish clear terms, formal agreements, and a realistic repayment plan to protect both your finances and personal connections.
- Peer-to-Peer (P2P) Lending: The rise of P2P lending platforms in Nigeria is tempting for quick cash, but these often come with extremely high interest rates and tight repayment schedules. If you’re not careful, what seemed like an easy way to cover an emergency expense can turn into a financial pitfall.
- Digital Loan Sharks: They exemplify bad debt through predatory practices, often imposing interest rates exceeding 300% annually. These lenders usually impose daily fees that range from 15–30% of the loan amount, which keeps borrowers entangled in debt. They also violate privacy by sending slanderous messages, which deeply distresses them emotionally. To avoid these pitfalls, look for reputable, regulated lenders, verify proper licensing, and ensure clear, reasonable repayment terms before accepting a loan.
Bad debt is any debt that doesn’t generate income or improve our financial standing. It often leads to more problems than it solves, and in Nigeria’s current high-interest rate environment, it’s especially dangerous.
Evaluating Debt Worthiness in Nigeria’s Economy
In our challenging economic environment marked by 32.15% inflation, fluctuating PMS prices around ₦855, and a volatile currency evaluating the worth of taking on debt has become increasingly vital. Rising costs necessitate careful consideration of debt’s benefits and risks. As we’ve explored, it’s clear that informed decision-making is essential for achieving financial security in turbulent times.
First, consider the cost of debt. With Nigeria’s Monetary Policy Rate at 27.25%, borrowing costs are high, making it critical to think through whether the return on our investment will outweigh the cost of borrowing.
Second, look at opportunity costs. What are we giving up by taking on this debt? For instance, if we are borrowing money to start a business, ensure that the potential earnings will justify the interest payments.
Lastly, always have a plan. A well-thought-out repayment plan is essential in this environment. We don’t want to find ourselves at the mercy of inflation and unpredictable fuel prices, which can erode our ability to service debt.
Scenarios Where Debt Is Advantageous
There are times when debt can be our friend. Here are two scenarios where debt could work to our advantage:
- Starting a Business: Let’s say you’ve been selling clothes from your living room and want to open a shop. A small business loan to cover rent and inventory could help you scale up, potentially doubling or even tripling your revenue.
- Buying Land: In Nigeria, land generally appreciates over time, given increasing demand from a growing population, making it a solid investment. Taking on a mortgage or land loan to purchase a plot in a prime location, can set you on the path to building wealth, as land value typically rises, even if the economy falters.
Key takeaway: In both cases, the debt is being used to acquire assets that will grow in value, helping you build a stronger financial future.
The Impact of Rising Costs: What You Need to Know
Now, let’s talk about the elephant in the room—Nigeria’s soaring Consumer Price Index (CPI), cost of PMS (petrol), and unstable currency. All of these factors can significantly impact the cost and sustainability of debt.
- Inflation: As the cost of goods and services increases, the real value of money decreases. This means that if you’re taking out a loan now, inflation might make the repayments more expensive over time. This is especially true for adjustable-rate loans, where interest rates can skyrocket as the economy shifts.
- Cost of PMS: With fuel prices rising due to subsidy removals and global oil price volatility, everything from transportation to food costs more. If you’re taking on debt for a business, be sure to factor in these rising operational costs, as they can affect your profit margins and ability to repay the loan.
- Unstable Currency: With the naira fluctuating against the dollar, import-dependent businesses may find themselves paying more for goods, making debt harder to manage. If your business relies on imported materials or products, currency instability can eat into your revenue, making debt a bigger burden.
The key here is planning. By anticipating rising costs, you can ensure that your debt, whether for business or personal investment, won’t backfire.
Leveraging Debt Wisely
Debt is a tool, not a trap if you know how to use it. The line between good debt and bad debt often comes down to one simple question: Will this debt improve my financial future, or will it only serve my present desires?
If it’s the former, you’re in a strong position to leverage debt to your advantage. If it’s the latter, you might want to rethink the decision. John’s story, where he borrowed money for consumption and ended up worse off, teaches us that debt taken without a clear plan for growth can be a financial disaster. On the other hand, Bola, who borrowed to invest in land, shows that strategic debt can lead to wealth creation.
Nigerians need to change how we view debt. Instead of seeing it as a shameful last resort, we should see it as a carefully considered tool for financial progress—one that, when used properly, can help us weather inflation, an unstable economy, and even personal financial challenges.
Key Takeaways
- Good Debt is Strategic: Good debt, such as business expansion loans, student loans, and agricultural loans, is a strategic tool that can enhance financial standing and lead to long-term wealth creation.
- Bad Debt is Costly: Bad debt includes consumer loans for non-essential purchases and predatory lending practices from digital loan sharks, which often come with exorbitant interest rates and unfavourable terms, trapping borrowers in cycles of debt.
- Economic Awareness is Essential: In our current economic climate—marked by 32.15% inflation and rising costs—it’s crucial to evaluate the implications of taking on debt carefully.
- Evaluate Debt Worthiness: Consider the costs and potential returns of any debt before borrowing. Ensure that any debt taken on aligns with a clear financial plan that prioritizes sustainable growth.
- Transforming the Perspective on Debt: Nigerians We should view debt as a carefully considered tool for financial progress rather than a shameful last resort, utilizing it to navigate economic challenges and build a more secure financial future.
