Good debt and bad debt

Is debt good or bad?

Most people will have some form of debt to manage their finances effectively and the key to a good relationship with debt is understanding which things are worth getting into debt for (good debt), whilst avoiding debt that has the potential to cause financial misery for you in the future (bad debt).

In simple terms, good debt is debt which helps build your wealth or increases your income over time. A mortgage to buy a house, a student loan to advance your career, or a loan to grow your business, are all examples of “good debt”. If you can afford the repayments, these debts can be a sensible investment in your financial future and should make you better off in the longer term. Good debts are underpinned by clear and specific reasons for having them, you will know from the outset when, and how, you will repay them, and you’ve ensured that the interest rates are appropriate based on your individual circumstances.  Importantly, they won’t negatively impact your overall financial position. 

Bad debts, on the other hand, are everything that good debts are not. They drain your finances and wealth, they seldom come with a clear plan on when and how you will repay them, and they are frequently driven by impulse and desire, rather than clear and specific goals. Although bad debts may bring short term satisfaction, in the longer term they can cause anxiety, stress and financial difficulty. We can end up paying for bad debt long after the joy or benefit of the purchase has disappeared.

Having a good relationship with debt isn’t about how much we earn, or even how much debt we have. It’s about understanding that good debt can enhance our financial future, whilst bad debt, with all the issues that it brings, should be avoided.

How to avoid bad debt

When considering borrowing money, ask yourself the following questions. If any of the answers are ‘no’, that debt is likely to be bad.

• Will borrowing this money improve my finances in the long run?
• Have I shopped around to get the best deal?
• Am I borrowing this money as cheaply as possible?
• Will I be able to cope should interest rates rise in the future?
• Will I comfortably be able to afford the monthly repayments?
• Do I understand all the terms and conditions associated with borrowing this money?
• Do I understand the risks and what could happen if things go wrong?

Once you have established that the money you want to borrow is a good debt, work out exactly how much to borrow and make a plan for paying it back. You can use the budget planner to ensure you have enough money each month to make the repayments. Borrowing more than you need without a plan for paying it back can swiftly turn a good debt bad.