Good And Bad Debt: What’s The Difference?

Is there such a thing as good debt? And what’s the difference between good and bad debt?

A simple definition of good debt is this, you can use it to buy things that will be beneficial to you in the future. Whereas bad debt only costs you more money and stops you from being able to afford the things you’d like.

It’s very possible that the two different types can spill over, especially if you haven’t worked out your repayments properly. Or if the situation in your life changes which means you may struggle to pay it off. Let’s look at some examples.

Positive Debt Examples

House Mortgage

This is a classic example of good debt. Unless you can afford to buy a house outright, it’s more likely that you’ll get a mortgage at some point in your life. A mortgage means you pay a certain amount each month to a bank or lender in order to live in your home. It’s good debt because you are providing shelter for yourself and your family, as well as investing in their future.

Student Loan

If you’re hoping to study in further education, most institutions now require payment. So you will probably need to get a student loan. Ultimately, this is an investment in your future. You are borrowing money in order to further your education and put yourself in a better position in the job market.

Car Loan or Lease

Perhaps you need a car to get to your job or it’s a special requirement of your job if you are visiting people. If this is the case, you are improving your ability to earn money by investing in a loan for a car.

Negative Debt Examples

Bad debt is basically debt that builds up and isn’t invested in anything. So you may love that jacket you bought, or the restaurant dinner you popped on credit, the shoes you had to have, or the new games machine for home. But you are paying much more for these items in the long run than you would have done if you paid in cash. Also, can you afford the repayments or are people starting to chase you for them? This can be a stressful experience, especially if you have lost track of what you owe.

Credit Card or Store Card

A credit card or store card can actually be useful when managed properly. However, using your credit card for day to day spending is a bad way to manage it. For many of us, it’s very easy to get into the habit of putting all our purchases onto credit. We think we can afford it later and will be able to pay if off. But in reality, most people can’t keep track of their spending. If this is you, then you should avoid getting credit cards.

Buying Furniture Or Household Items on Finance

Maybe you really want that new sofa, but do you actually need it? Have you got a perfectly good working one at home? If you do need a new sofa, entering into a finance deal can lead you into more debt. Remember, you will end up paying more for the sofa in the long run than if you bought it with cash. That’s because of the interest added onto the finance loan. If you are looking at this option, always read the small print and work out how much you will pay for the sofa after your loan has ended. Is it worth it?

Personal Loans

A personal loan is another debt where you won’t get anything at the end of it apart from a bigger debt. Look at it this way, if you are using a personal loan for a specific purpose that you will gain from, it could be seen as a positive thing. However, there are several risks to taking out a personal loan. Always work out how much it will cost you in the long run. It’s very easy to fall behind on payments if they are unmanageable, and then you could be at risk of losing your purchase or investment altogether.

How To Prepare For Investing Money

Debt can sometimes be good if the purpose is to improve your financial situation. For example, perhaps you want to start a small business, you have your plan in place and now you need a loan agreement.

Or, you have seen the house you’d like to buy and you’ve spent ages saving for the deposit. Now you’re ready to secure a mortgage deal.

Essentially, you are investing in your future and you may get more money out of it in the long run. Therefore, you are choosing to take on this debt.

The key advice here is to research and shop around for different options. When it comes to a loan, you are looking for favourable interest rates, lower charges and fees. As well as this, you must be able to afford the repayments. Draw up a budget of all your monthly outgoings and check you can afford it.

Similarly, there are different mortgage options. Speak to a few lenders and compare. There are different styles and types which may suit your situation more. You don’t have to opt for the first one you see or a mortgage lender that your estate agent advises.

What To Do When It Goes Wrong

If circumstances in your life change, and you can’t keep up with your repayments, then seek advice as soon as you can. There are many charities and free advice phone lines for help and support.

Finally, if you are heading for difficulty due to your lifestyle choices, then it’s time to face that now. Bad debt will affect you for years and may prevent you from being able to do things or invest in your future when you come to that stage.