Spotlight on Debt: Good Debt vs Bad Debt
This month, we are taking a look at Debt. What is it, how to ensure you only take on good debt, what to do if you find yourself with bad debt etc. Debt is one of those intimidating words. It feels like we’ve had it drummed into us since childhood that debt is a bad thing and you should try to avoid it at all costs.
Let’s start by demystifying it. In its simplest terms Debt is the money that you owe to someone or something – be it a friend or a company. Debt comes in many forms – from the mortgage that you use to purchase your house, to the loan you take out to pay your car. Debt includes money you owe on credit cards or store cards, or your student loan. Debt is a part of our everyday lives. Very few people can live completely debt free, unless you have been lucky enough to have been passed a large sum of money and property from birth.
A lot of the debt we take on is defined as good debt. Good debt is an investment that will grow in value or generate long-term income, it should not have a negative impact on your financial position. A good example is a student loan to pay for college education, because it’s an investment in your future and you will more likely have better career prospects and earning potential in the long run, so your debt will more than pay for itself. A mortgage is another example of good debt because it enables you to purchase the house that you will live in and once paid off you will be able to remain in your home, which is likely to be a good financial asset. Likewise buying a car to enable you to work, or investing in your own business (providing you have a sensible and realistic business plan).
If you are taking on good debt, you will have a clear reason for taking it out and a realistic plan for paying it back, which includes the option of paying back as quickly as possible or in regular instalments. Good debt involves you having done your research, so that you have found the best deal for you – does the borrowing method, interest rate, loan or credit amount and terms and charges suit you? This isn’t always going with the cheapest option – especially if that option comes with high charges or penalties. We can’t emphasise this enough – DO YOUR RESEARCH.
So, what constitutes bad debt? Bad debts aren’t affordable, cost you a lot of money to have and offer no real prospect of ‘paying for themselves’ in the future. They are unlikely to have realistic repayment plans. They are often the result of people making impulse purchases that they don’t really need. Or when people borrow money to pay every day bills that should be covered by better management of income. The bottom line is, if you borrow money that you can’t afford to pay back, it’s a bad debt.
There are certain items that you really shouldn’t get into debt for – you should save in advance and pay them off as quickly as possible:
- A luxury holiday – your holiday of a lifetime could easily turn into a lifetime of debt, so make sure you have a plan to pay for it or fix your budget and find a holiday according to how much you can afford.
- A brand new car – the saying ‘a new car loses money the minute it leaves the forecourt’ is generally true, so only buy one if you can afford to pay the debt back. Remember that if something unexpected happened like losing your job and you had to sell your car to pay the debt, you wouldn’t be able to sell it for the amount you bought it for. Fix yourself a realistic budget that you can pay back each month in all eventualities and look for a car that suits that budget.
- Paying bills and other credit – if you find yourself in a situation where all your income is used up on essential bills and items like food, water, heating etc. and you are still having to take out loans or put bills onto credit cards, just to get through each month, then it’s time to get some expert advice. Citizens Advice, Step change and the National Debt Foundation are all good places to start. The Money Advice Service has a very helpful page with lots of sources of information: https://www.moneyadviceservice.org.uk/en/tools/debt-advice-locator
So how do you ensure any debt you take on is good debt? The Money Advice Service recommends that you ask yourself the following questions and if any of the answers are ‘no’, the debt is likely to be bad:
- Have I thought about how much I want to borrow, how much that will mean I will pay back each month and whether I can realistically afford this?
- Have I shopped around to get the best deal?
- Am I borrowing this money as cheaply as possible?
- Unless the loan is fixed, will I be able to cope should interest rates rise in the future?
- Will I comfortably be able to afford the monthly repayments?
- Will borrowing this money improve my finances in the long run?
- Do I understand the risks and what could happen if things go wrong?
- Do I understand all the terms and conditions associated with borrowing this money?
Good debt can swiftly turn into bad debt if you don’t have a plan to pay it back – whatever the reason for taking the debt on in the first place. Responsible lenders like TFS Loans will go through affordability checks with every customer, before agreeing to lend money. This is an essential process to ensure that the debt that our customers take on is good debt. Customers can consolidate their debts by taking out a TFS Guarantor loan to repay several other lenders. For more information on our Debt Consolidation Guarantor Loans visit our Debt Consolidation page.
TFS Loans are specialist Guarantor Loan lenders. A Guarantor Loan is a form of loan that requires someone to act as the Borrower’s Guarantor. We offer Guarantor Loans from £1,000 to £15,000, over 1 to 5 years. 44.9% APR Representative.