Banks prefer bad debt, why is that?

First some definitions:

  • Bad debt is debt that was incurred for a liability, for example, buying cars, throwing a party, buying a boat, going on a trip.
  • Good debt is debt that is used to buy a producing asset. Debt used to start a business that is producing profit, buy a property that produces rent, etc.

I once asked a bank for a loan. The loan would have been given to me on the basis of my salary, track record in earning money, credit report, and current affordability level. Still they asked me what I was planning on doing with the money and I told them I was planning on investing them in one of my business and on that basis the told me that I was rejected because they don’t do business loans. Mind you, I wasn’t asking for one, I was asking for a personal loan.

Naively hoping to still qualify I explained that my business was buying property abroad and that it was a really good deal. Their answer was that I should talk to the mortgage department because they don’t do loans to buy property because then the property could be mortgaged and lost and they are left with nothing (nothing except every single payment coming out of my salary, mind you).

When I talked to the mortgage department they told me what I expected: they can’t offer mortgages abroad.

Later on I went to the same bank, I asked for the same amount and I told them I was planning on blowing it all out on a party. They said yes. Now that I was planning on just spending it on one single event of which no good financial outcome could come out, my salary was good enough for them to say yes to the loan. I asked what if I wanted to spend it on a highly depreciating asset, like a car, and they also said yes.

It seems like banks prefer you to have bad debt, than good debt. I don’t know why it should matter one way or another if the collateral is the salary, not the asset, but if it matters, why does it matter in the wrong direction?

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