Good Debt Vs Bad Debt – Know the Difference

example of bad debt designer shopping

Good Debt Vs Bad Debt – Know the Difference

Do not be scared of debt as a general concept. Instead, think of it as a tool to use when seeking to improve your life, or your financial situation: to increase earnings or to invest in your future.

Before you consider borrowing money, ensure you understand the difference between good debt and bad debt; how one can help and one can hinder your future.

Ask yourself: 

  • What types of debt could help to improve my finances and my life? — AND —
  • What is the worst type of debt to take on?

If you don’t know the answer to either of these questions, then the notes below will help you to decide how best to proceed.

 

So, what is GOOD DEBT?

Someone with a GOOD DEBT will find the cheapest possible way of borrowing money, whilst ensuring the Lender is professional, helpful and approachable, knowledgeable and efficient . 

With the appropriate guide from the Lender, they will have sought out the best borrowing method for them; the interest rate, loan or credit amount, plus the term and charges that fit their ability to repay.

A GOOD DEBT is one that is a sound investment in a financial future, leaving the Borrower better off in the long-term. It should not have a negative impact on their financial position, if the amount and relevant charges are within capability.

The Borrower needs to be sensible about what repayments are affordable. And needs to be aware of the different deals available. The lowest interest rate may come with the price of higher charges or penalties.

GOOD DEBT is defined as money borrowed to pay for items truly needed or that appreciate in value, or that will improve life’s opportunities in the long-term. 

For example….

 

  • A Mortgage can be a good debt providing a home to live in and ultimately a big financial asset, generally increasing in value.
  • A Student Loan to pay for University is a good debt, as graduates tend to find jobs more easily and typically get paid more than non-graduates.
  • An Education Loan to pay for Private Schooling, to give the children a great start in life.
  • Paying for Medical care to keep a loved-one healthy and alive is surely a debt worth taking on. It is defined as a good debt, even though the return is not a financial one.
  • Business loans to expand an existing, successful company, or to start one – with a fool-proof Business Plan – is accepted as a good debt because there should follow a good return on the money borrowed.
  • Fine Art, Jewellery, Antique items, First Edition Books, and many collectable things rate as good debts, because they often increase in value from the time they are bought.

 

There is a GREY AREA between GOOD and BAD debt and that is in the field of car purchase: 

Purchasing a car is a good debt IF it is a sensible buy to enable travel to work, driving for work or to avoid excessive train fares. 

Buying a brand NEW car is usually defined as a bad debt because it loses value the moment it has been driven off the forecourt. However, if it is felt that the car will impress your Business Clients with the value of the car and therefore the Business, it may be seen as a good debt.

 

And, what is a BAD DEBT

BAD DEBT is accrued for items you want (but do not need) and that generally depreciate in value. Bad debts drain wealth, are not affordable and offer no real prospect of paying for themselves in the future.

If the Borrower hasn’t been completely honest with their self about what loan or credit they can afford, or the person isn’t sure they will be able to make the regular monthly repayments it is definitely a BAD DEBT.

For example…

 

  • Borrowing to pay previous debts, like bills and over-extended credit cards, are counted as a bad debt. In most instances, by the time the credit cards are paid off (if ever) the interest rates and minimum payments can turn a £100 item into a £200 one – and as many items depreciate in value rapidly, the loss may very likely be even more substantial.
  • Jewellery and Designer Clothes are Bad debt items of craving – completely wants and not needs, with new designs appearing the very next day, thus reducing the value of these treats. If these luxury items cannot be paid for by cash, it is best not to even think of buying them. 
  • Payday Loans are the pinnacle of Bad Debts (often considered to be the worst kind of debt you can take on). It may be easy to borrow money from payday loan companies, but it is very difficult to pay them back. These companies loan out money with terrifyingly high interest rates, taking advantage of the fact that many people are desperate for cash. Even a small amount borrowed through a payday loan outlet can end up costing a small fortune when finally paid back.
  • Thinking of taking out a loan to go travelling? It is a great idea, but another of those bad debts. Travelling usually ends up much more expensive than you calculated and whilst you’re away there’s no salary mounting up to pay off your debts.

 

So now you have a better idea of how to evaluate needs against wants.

 

Once you’ve established that the money you want to borrow is a good debt, you need to work out exactly how much to borrow and how you’re going to pay it back.

Modern life requires many of us to borrow money at some point. Knowing the difference between good debt and bad debt can make a big impact on your financial health and chance of success.

It is best not to incur more debt than you can comfortably afford to pay back, regardless of whether it is good or bad! Be aware that borrowing more than you need, without a plan for paying it back, can swiftly turn a good debt into a bad one.

 

 

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