Category: Debt

Debt

Differences between Good and Bad Debt

In some peoples head all debt is the same thing. Some worry about being in debt, do not like idea of it and will not consider it. However, there are different types of debt some are good and some are bad and it is worth looking into both to enable you to distinguish between them.
Good debt is where you borrow money for a purpose that will actually gain you money. This applies to most mortgages, student loans and interest free credit. In these situations you will be investing the money that you borrow and you should make more than you spend. With a mortgage, for example, the home that you buy should increase in value enough to cover the cost of the mortgage and therefore it is seen as an investment. You will end up not having to pay rent, owning a home which should increase in value and therefore gaining more than you have spent. There are of course exceptions to this as some homes decrease in value should the area they are in suddenly become less valuable perhaps due to flooding or the desirability of the area. If you do not keep up the repayments on the mortgage then you could end up paying a lot more for it than you would otherwise and you might find that you lose the house in the end as well.

A student loan pays for a course which should improve your employment prospects and allow you to get a better paid job, but you will need to choose your course carefully to make sure that it will offer you that. Some courses will lead to great careers but others may be more theoretical and they may not naturally lead to a job, which could mean that you are not much better off having the degree than if you hadn’t got one in the first place.

Interest free credit can be fantastic. It means that you can buy things and not pay for them for a while. You can put the money that you would have spent in a savings account and then get the interest on it until you need to pay back the debt. This has better results when interest rates are high as you can get a bigger return on the money that you are saving. You do need to be careful though and make sure that you repay when needed or else it will not be worth doing. You will find that the fees and charges could be extremely high.

Bad debt is usually things like credit cards, overdrafts, store cards and other debt where the money has been spent on unnecessary items. If you borrow money to buy new clothes, home decorating items, or anything else that is unnecessary. When you borrow money you end up paying a lot more for items that you buy with than if you had used money that you had already or waited to save up. It can feel very hard too, when you have lots of debt and do not have very much to show for it as clothes wear out and homes need decorating regularly.

Not everything can be neatly categorised into good or bad debt though. For example, borrowing money to buy a car for a job interview as it is the only way you can get there but risking not getting the job, or borrowing to buy your children lovely Christmas gifts, which are obviously a luxury but would mean a lot to them. It can be a very personal thing to you as to whether you think buying something is necessary or not.

Everyone has very specific reasons for borrowing money and only they know how important it is for them to have it. Only they can evaluate whether they think that the loan will be good for them or not. They will have to consider both sides, the advantages and disadvantages of taking the loan but also of not taking the loan and decide whether they want to do it. There are some very clear cut examples of good and bad debt but most types of borrowing fall somewhere in between and it is much harder to judge whether it is something worth doing or not.

Whether the debt is good or bad it will need to be repaid. It is therefore not just to evaluate whether it is good or bad but also to consider if you can repay it. Good debts tend to be longer term, which may mean repayments are smaller but it will take a very long time to pay them back and you have to decide whether you are going to be able to commit to this. Even with a short term loan you still need to make sure that it can be repaid.