With debt becoming an increasing issue in our society, it is important that we remain properly informed and don’t shy away from asking pertinent questions. The facts surrounding debt are not always clear-cut or simple to understand and promoting healthy communication around this topic is vital. A highly pressing concern for many, according to one source, is the intricate differences between what is known ‘good debt’ and ‘bad debt’.
You might not even know that ‘good debt’ exists as a concept, and it isn’t without its critics — some of which assert that all debt is bad debt. However, the general consensus is that the nature of your debt ultimately depends on whether or not you will profit from this deficit long term; in essence, some debt can be seen as an investment to ultimately boost your financial health.
What is good debt?
If you are trying to determine whether or not a purchase is in fact ‘good debt’, it is best to start with your overall intentions. Something bought purely to amuse or entertain, such as the latest gaming console, is not likely to be considered good debt. If, however, the asset or purchase will earn you something in the long run or will create value over time, the debt can be considered ‘good’ or ‘productive’. Essentially a good debt is a sensible investment that will serve to improve your financial future. You will have a plan to pay back the money and a very specific reason for taking out the debt.
Specifically, examples of good debts include investments such as student loans. It may feel daunting to be thrust into debt so early in life, especially given ever-increasing tuition fees, but when you consider your greater earning potential upon the course’s completion, the debt can be put into financial perspective. In addition to this, interest rates on student loans is always respectably low. When you also accept the reality that you will have to be earning a set amount before you begin repayments, a university education begins to show itself to be a rather wise investment and a good debt to take on.
Other examples generally considered to be good debt are things such as mortgages, as house prices generally increase, and investing money into your business, as long as you have a strong business plan. Investing wisely in stocks, bonds, and shares could also another example of good debt.
People who create good debt tend to be those who do their homework and identify the cheapest and smartest ways to borrow the money. There are myriad avenues to borrow money these days and many of them are not a financially sound decision. Notorious examples are payday loans and other loans with extortionate charges or penalties.
What is bad debt?
If good debt is productive, wise and profitable in the long run, bad debt is the polar opposite. Far from creating any value, they are generally unjustifiable expenses, disposable items or impulse buys that don’t serve to improve your financial stability but rather hinder it simply for short-term pleasure. People who indulge in bad debt often don’t consider reasonable repayment plans or look into the details of interest rates or charges.
Examples of bad debt include excessive spending on clothes, shoes, or accessories, which in reality won’t provide much, if any, return on investment. Using borrowed money to purchase a lavish new car is also considered bad debt, as most cars lose between 50% to 60% of their value in the first three years. More examples include failure to make credit card payments, which not only cause extra charges but also negatively affect your credit report, and going on luxury holidays when you don’t have the means to afford them.
To avoid bad debt, it is important to carefully and consciously consider each and every purchase or financial decision before pressing ahead. Ask yourself whether you really need the item in question or whether it is something you can live without. Don’t fall victim to the commonly bandied-about rhetoric that you need to “spoil” yourself every now and then; treats like these can serve to seriously damage your credit score and might ultimately result in extortionate debt you can’t feasibly repay. Even if your credit is low, there are bad credit loans available to you.
About the author:
Yaakov Smith, a first class honours graduate of Oxford University, has almost twenty years’ experience developing and designing software. He is the CEO of Logican Solutions, a UK-based business management software company that serves to streamline processes and increase productivity. They offer a range of products, including solutions for claims management, debt management, and property portfolio management.
