People often say that ALL debt is bad debt and that you should never have debt. This may seem like a sensible thing to say. However, the reality is that most of us will have to take out some form of debt in our lives. Most consumers don’t have large piles of money lying around to make large purchases such as homes or vehicles. Similarly, most entrepreneurs or small business don’t have piles of cash to fund their business or acquire assets or pay staff. Debt is required in these circumstances. Some of these debts can be good debt.
The other argument is that there are two types of debt one can take, good debt or bad debt. Now, there are no distinct rules as to whether a debt is good or bad. The principles outlined below will help you to decide which category your current or future debt falls under.
What are “Good” debts?
It’s easier to start with good debt. Debt that is used to create value is known as good debt. A business might need a loan to buy equipment, a premises or other assets which allow them to start making money. A consumer may need to buy a vehicle in order to get to and from work, which allows them to make money. Owning a home can create value and most homes are bought with a bond. It normally takes 20-25 years to pay off a bond. Homeowners generally realise an increase in property value or can now rent it out for extra income.
Some people take out loans to invest in other companies, which they believe will increase in value. The intention of these debts is to increase and create extra value. There are always risks associated with these loans. The business could fail, tenants may not pay their rent or you may have an accident and not have comprehensive insurance on your car.
What are “Bad” debts?
The more common debt category is that of the bad debt. Unnecessary shopping or luxurious purchases are the most common types of bad debt. These debts add no value. They may make you feel nice and happy for a bit, but essentially, they cost you lots of money. Taking out a loan to buy new clothes, or a new TV, or to go on a holiday may not be a good idea. Items bought with a loan actually cost you more than the item itself after the fees and interest of that loan. It is possible to sell the clothes or the TV but it will be for less value than you paid for it and you would have made a loss.
What can you do if you have a lot of bad debt?
Try avoiding using debt for day-to day expenses and try to budget. Budgeting will help you afford the lifestyle your salary allows and can help you to save. Instead of buying something with a loan or on credit, try saving up for a few months. After a period of time you may be able to afford the item using cash.
If you already have too much debt and have fallen into the bad debt trap, contact a debt counsellor who can help you to reduce your debt payments and save you money. Debt counsellors offer a range of debt services based on your financial situation and they can help you to make the wise choice and get debt free as fast as possible.