Good vs Bad Debt
Jessica Jones, Obp Chartered Accountants | 31st January 2020
The more you know about debt and money, the more control you will be of your finances. Years ago I didn’t know that there was something called good debt! I always felt guilty that I was in debt as if it was something to be ashamed of and I was always stressed and scared of it too. However, with progressing age I have learnt that some good debt has helped me manage my finances and generate income. However, I am still vigilant about whether I can afford re-payments and most importantly why I need to get into debt. It also must be highlighted that no form of good debt is a sure bet with a guarentee of long lasting value.
What is considered a good debt?
- Buying property with a mortgage loan is one of the best examples of a good debt. That is because mortgages come with relatively low interest rates, you purchase a property in which to live without spening ‘deadmoney’ on rent and a home’s value tends to increase over time so you’ll hopefully get the benefit of selling it for more than you paid for it. In otherwords you’re investing in an asset that grows. You can also buy further properties in which you can generate rental income.
- Investing in a business can be considered a good debt, as long as it is a viable opion with a good and sensible business plan. It can generate an income stream and potentially creates an asset you can sell or pass onto your family.
- Getting a student loan can be described as investing in your future. By furthering your education can help provide you with better career opportunities and university grduates typically get paid more than non-graduates. The interest rate is relatively low and you only have to repay the loan once you’re earnong more than a certain amount.
- Car Loans can be seen as both good and bad debt. With the exception of collectable high-end vehicles, cars are not considered an investment. In fact as soon as you drive a new car from the garage forecourt it looses on average 10% of its purchase price. All cars depreciate with age and some more than others. However, if a car is essential to get you to work to earn a living and you can afford the loan repayment and the running costs it can be seen as a good debt.
What’s considered Bad Debt?
Bad Debts are those that drain your money, are not affordable and offer no prospect of paying for themselves in the future. Also bad debts are sometime good debts gone wrong.
- Using a high interest Credit Card is a really expensive form of debt. If you can’t afford to pay off your credit card each month then you could be in trouble. If you only can pay the minimum it is unlikely that you will get rid of the debt, which will be more expensive as it will take longer to pay off. If you miss payments your debt will grow as you will be charged fines and this will also affect your credit score. Before you miss any re-payments consider a 0% interest balance transfer credit card to make your credit card debt more affordable. You will defintiely need an excellant Credit Score to have one of these.
- Many people get into bad debt by having personal loans for high end purchases. Think before you buy and decide if the purchase is worth the stress and possible repercussions of not being able to pay it off.
- Payday loans are specifically designed to quickly provide money to people who would normally struggle to get such loans because of their bad credit. These loans are bad debt that can turn toxic in nature as often interest rates can be as high as 300%. Due to the high interest rate it is easy to fall into the cycle of debt and never be able to get out of it. There are alternative to payday loans such as borrowing form a credit union, asking family or friends for help, getting an interest free loan from the government (if you are claiming benefits) and applying to the Community Development t Finance Institutions. Please always ask for help before getting a payday loan.
What are your options?
If you are stuck with bad debt or if your circumstances have changed which results in making good debts less affordable, here are the options you can consider.
- Debt consolidation is considered a good idea as it converts costly high interest credit card debt into low interest easy to manage monthly payments. All your debts are in one place and you only have one interest rate and one monthly payment to keep track of each month. Your credit rating could also improve because once you close other credit card and loan accounts and lenders can see that you are managing your finances responsibly, your credit rating could go up as long as you maintain your payments.
- Credit Advice and Counselling should be considered if you are finding difficultly and you need expert advice. You can contact non-profit organisations free of charge, who will provide you with the correct advice and can devise detailed plans of action to help you deal with your debt. They will also speak with creditors on your behalf. Please be aware that you need to contact non-profit organisations as some companies that advertise free advice may end up charging you in the end. These are the 3 most popular organisations that can help you.
I have tried to explain what debt is and how you can make good debt work for you but also what constitutes bad debt and how you can deal with it effectively. Debt not only places a huge financial burden on people but also places a huge amount of stress which can affect people’s mental health. Please be aware of how much debt you take on and whether you will be able to make monthly payments even if your circumstances change, shop around for the most favourable interest rates, charges and fees and ask yourself whether the debt providing the financial benefits outweigh the costs? Finally, please be prudent, enter into debt with your eyes fully open and try make debt work favourably for you.