Even amongst all those other four-letter words, debt is a massive taboo. Having substantial debt that’s gotten out of hand is a massive burden, not to mention very embarrassing to a lot of people! If you’ve managed to stay relatively with your personal finances so far though, you may not be aware that there’s such a thing as “good” debt. Sure, owing a lot of money to other people or institutions can be crippling. However, if you understand all the little details, and you know how to handle it properly, debt can work for your interests, rather than against them. In this post, we’ll look at the differences between good and bad debt, and the best ways to handle them.
So, what exactly is “good debt”? In the simplest possible terms, good debt is any debt which is tied to a smart investment in your future. If it’s going to put your personal finances in a better position in the long run, without and kind of long-term deficit, then it’s probably an example of good debt. You need to have a clear, specific reason for taking the loan out, along with a realistic and measurable plan for paying it all back. When you take out a mortgage, for example, the creditor will usually come up with a plan for paying it off in affordable, regular payments. Good debt is also defined by the debtor finding the cheapest possible way to pay the money off. Whether it’s a conventional line of credit or through a short-term lender like Swift Money, you need to make sure you’re choosing the most cost-effective option if you want good rather than bad debt. If you’ve never taken out a substantial loan before, then this may sound easy. Believe me, it’s not! The borrowing method, the actual amount of the loan, the interest rate, the term and any additional fees tied to the loan will all come into play. Some people go into it thinking that the most cost-effective option is the one with the lowest interest rate. This isn’t necessarily true. Many loans with notably low interest rates often come with harsh financial penalties, which can be extremely crippling if you can’t keep up with them. Finding the best combination of all these factors can be a real challenge, but it certainly pays off in the long run.
Here are just a few examples of when taking on debt can be a sound financial decision. A student loan is probably the most obvious and commonplace example of good debt. Graduates usually get paid a lot more than non-graduates after they’ve completed their education, for starters. More importantly though, the conditions surrounding these particular loans are very favourable to the debtor. Student loans have very low interest rates, and often none at all! Furthermore, you’ll only have to pay it back at all if and when you’re earning a salary above a certain amount. Mortgages are another common example of good debt. I’m sure you’ll agree that owning the roof over your head is a good thing! The main factor that classifies a mortgage as “good debt” however is in the value of the house. Once you’ve paid off a mortgage, the house you’re left with will be a major financial asset. Property is likely to grow in value over a long period of time. Furthermore, the mortgage payments you have to keep up with could be cheaper than the rent you could feasibly charge if you were to rent it out. If you own a business, and you take out a loan to invest in it, this can also be considered good debt. However, this hinges on the state of the business of the time, and how realistic or sensible your business plan is. If everything goes to plan and your business goes through a lot of healthy growth, then its worth will end up far more than the loan you originally took out. Finally, buying a car in a cost-effective and manageable way. Cars are more or less essential for a lot of people in 2016. If you can comfortably afford the running costs and the loan repayments, then this can also be considered “good debt”.
Bad debts, as you can probably imagine, are any debts which have the potential to drain your wealth, aren’t affordable, or don’t have any realistic prospects of being able to “pay for themselves” in the foreseeable future. They’re often characterised by spur-of-the moment impulse buying, and usually have poor or unrealistic payment plans tied to them. Other common examples of bad debt include borrowing large sums of money to pay normal, every-day expenses like food and bills.
You may have read this brief description and laughed at the thought that you’d ever let your household be burdened by bad debt. However, people with bad debt are far more common than you may think, and the pitfalls are often extremely tempting! To avoid it, you need to think very carefully every time you’re about to make a big purchase through any kind of loan. Generally speaking, if you know you can’t afford to pay the debt off in a short term, then it’s best to avoid it. That luxury holiday may be just what the doctor ordered. However, if it’s going to chain you to a substantial debt for years afterwards, you should find another option. Try adjusting your spending habits, or reworking your plans to make the trip more affordable. That gorgeous new car that’s just appeared at your local showroom may be keeping you awake at night. However, if you can’t keep up with the repayments, the loan will probably end up costing you more than you’ll ever be able to sell the car for. You’d not only lose your vehicle, but be left with a substantial debt to pay off too. The most worrying kind of bad debt is when you have to borrow to keep up with your monthly bills and living expenses. When you get to this point, you know that your personal finances are in need of some serious attention.
At the end of the day, avoiding bad debt is a matter of foresight and common sense. Every time you consider borrowing money, you need to ask yourself a few key questions. Consider if the loan in question will improve your personal finances in the long run, and if so, how significant it will be. Before you settle on any one creditor, you should also check that you’ve shopped around and found the best possible deal. How easy will it be to keep up with the required repayments? If the interest were to rise sharply in the future, will you be able to accommodate for this? Make sure you’ve read all the relevant terms and conditions, and that you understand what they all mean. I’m sure I don’t need to tell you how many people have shot themselves in the foot by not reading the fine print! Most importantly of all, you need to understand the full extent of the risks you’re accepting by taking out the loan. If you miss a payment or two, then you may be able to recover the lost ground with ease. However, are you prepared to live with the detrimental impact on your credit score?
Hopefully, this post has given you a clearer idea of your current debts and any loans you may take out in the future. Remember to always think ahead, shop around for creditors, and keep a close eye on your household’s spending habits.