Why is personal debt bad

Debt allows individuals to make purchase today by pledging some of their tomorrow’s earnings. Is there anything wrong with having a little - or a lot - of debt? That depends on what the debt does for you - and it should always be more than what you do for the debt.

Will this debt pay me back more than what I put in? After you factor in principal repayment, interest payments and the alternative uses of that money, does the debt still make sense? Are you getting all your money back and then some? Could you have done something better with the time and money you are investing?

• Debt can be "good" if it has the potential to increase your net worth.
• Bad debt is money borrowed to purchase depreciating assets or assets for consumption.

Any time you take out a loan or charge something on your credit card, you are borrowing from the money you hope to earn in the future. You never know what changes may happen in your income, so it is better not to mortgage your future.

Considered at the global economy level, there is a tradeoff between the short-term benefits and the medium-term costs of rising debt. Since 2008, household debt as a proportion of gross domestic product has grown significantly in a sample of 80 countries.

Households take on more debt to buy things like new homes and cars. That gives the economy a short-term boost. But later, highly indebted households may need to cut back on spending to repay their loans. That is a drag on growth. And as the 2008 crisis demonstrated, a sudden economic shock – such as a decline in home prices–can trigger a spiral of credit defaults that shakes the foundations of the financial system.

It is, however, interesting to understand what makes debts attractive. As with majority of my premises – the answer lies in the human evolution. Multi million years of evolution has prepared us for an environment that is drastically different from our current environment. We are maladapted to our current environment, as a species our pace of change now outstrips our ability to adapt. For a hunter – gather – forager (and earlier hominins), their body and mind were primed for their day-to-day survival. So instant gratification was the thing. And this manifests into various different forms in the modern society.

Hyperbolic discounting is our inclination to choose immediate rewards (debt financing to buy today) over rewards that come later in the future (saving enough to buy later), even when these immediate rewards are smaller. Hyperbolic discounting can result in poor decision-making because it incentivizes impulsivity and immediate gratification.

Part of the reason for this, is that we have difficulty understanding long-term consequences. We are bad long-term planners. Trying to imagine and interact with your future self can help in making decisions that support your long-term future. Picturing the “you” that might result from your short or long-term decisions might influence you to make decisions that favor the latter.