Debt can generally be split into good and bad but there can be some confusion as to what the difference is. This is not helped by the fact that some people will try to tell you that all debt is bad whereas others will say there is never any harm in it. It is good to establish the difference so that you are clear with what the principles are and then you can make easier decisions when you are deciding whether to borrow money.
What is Good Debt?
- Good debt is when you borrow money same day that will help your financial future. For example, if you use a mortgage to buy a home, then you will not have to pay rent once you own the house and the home should increase in value while you are living in it. Another example would be a student loan where you will be using the money to pay for a course that will help you to get a better paid job as a result. So anything where the loan is going to help you to improve your financial situation as a result of what you spend the money on.
- There may also be emergency situations where the consequences of not borrowing the money could be far worse than the consequences of borrowing. For example, if you cannot pay your rent and could be evicted you may have no other choice but to borrow the money.
- With good debt you also need to have made sure that you have the right type of loan for what you are borrowing for. So, a loan which will give you the right amount of money and not too much and that will give you good value money. It is important to compare loan types to make sure that you are using the best one. You will also need to compare lenders to make sure that you are not paying too much. There will be quite a difference in prices between lenders and you will need to make sure that you check to see which one will give you the best value for money. Of course, the cheapest will not always be the best, but the most expensive may not be either.
What is Bad Debt?
- If you borrow money for things that will not help your future financial situation then this will be considered to be bad debt. For example, if you borrow money to buy three televisions for your home, to replace ones you have already that are only a month old. This is an extreme example, but it shows how a bad debt can be a luxury item which it is not really necessary for us to own.
- You might think you need money for an emergency but make sure that you check. For example, if it is for rent or a bill of some sort, then get in touch with the company you owe money to first and see whether they can help you. They may be able to delay the payment for you or let you pay it a bit late. So, make sure that it really is an emergency situation.
- If you take the first loan that you come across, without checking out what loans there are, then this is bad. Loans vary a lot and some will be much more suitable to your needs than others. It is well worth finding out about all loan types so that you will be able to pick the one that you know will be the most suitable for you. Also do not rush into a loan until you have compared the lenders – if you do this it could be bad debt. If you rush then you could end up paying more than you need to or not getting good value for money, perhaps because you will not choose a lender that properly suits your needs.