Debt often gets a bad reputation. Most of us associate it with stress, high interest payments and the fear of any accidently missed repayments negatively affecting our credit reports. But not all debt is created equal. Sometimes, borrowing money can be a wise financial decision that helps build wealth and improve your future. In this blog we will explore good debt vs bad debt, giving examples of when going into debt is generally considered okay and when it is best to avoid debt.
Difference Between Good Debt and Bad Debt
Before diving into specific examples, let's clarify the difference between good and bad debt. Good debt typically helps you buy assets or boosts your earning potential in the long run. This includes things like borrowing to invest in education, buying a home or starting a business. This form of debt tends to have lower interest rates and any assets you buy with it have the potential to grow in value over time.
On the other hand, bad debt usually involves borrowing for things that will not increase in value or contribute to your financial wellbeing. Credit card debt is a typical example, especially when it involves high interest credit cards used for non-essential purchases. Even if your starting balance is not big, but you only make minimum payments on your credit card, the debt can pile up fast, costing you a lot of money in the long run. So, before borrowing, always ask yourself whether the loan will help improve your financial situation or simply increase the amount of debt you already owe.
Buying a Home
For many people in the UK, taking out a mortgage to buy a home is their biggest financial commitment. However, a mortgage is considered good debt because it allows you to own an asset that typically appreciates over time. As house prices tend to increase, the money borrowed for your home could grow in value, potentially boosting your net worth. With sound financial planning, a mortgage is usually one of the safer forms of borrowing. Plus, mortgage interest rates tend to be much lower than other types of loans, making it more manageable to borrow large sums of money over a long period of time.
Starting a Business
Another example of good debt is borrowing money to start or expand a small business. Whether it is through a small business loan or a personal loan, borrowing to set up or grow a business can be a wise investment in your future.
If the business succeeds, you will be able to repay the loan and use the remaining proceeds to increase your income and overall net worth. However, it is essential to have a solid business plan in place and understand how much interest you will be paying on the loan to ensure it is a sensible financial decision. Don’t be too optimistic with your business forecasts, because if it doesn’t work out, you would have lost not only your time and energy, but still be left with your business loan to repay.
Student Loans
Student loans can get mixed reviews, but they are typically considered good debt in the UK. Investing in your education can bring you better career opportunities in the future and increase your potential earnings over time. In fact, many people find that taking out a student loan helps them secure a higher paying job, allowing them to repay the debt and still have more money than if they hadn't pursued higher education. However, you need to borrow responsibly and remember that you will need to start paying back your student loan once you start earning over the repayment threshold.
A Car Loan
Car finance is in the news a lot at the moment. While some might consider a car loan bad debt, because cars usually lose value over time, in some cases, borrowing money to buy a vehicle is a necessity. A car loan can be a practical solution if you need a car to get to work or for family commitments. But be careful – borrow only what you need and look for loans with lower interest rates. You should also aim to repay the loan quickly to avoid accruing more debt. A car loan is one of those debts that can be both good and bad depending on your financial situation, the car's value and the loan's interest rate.
Avoiding Unnecessary Debt
While these examples show that going into debt can be okay, it is important to avoid unnecessary borrowing. Taking out loans or maxing out your credit cards for non-essential purchases or luxury items can lead to more debt and high interest payments that are hard to sustain. Bad debt can negatively affect your credit history, unnecessarily pushing your credit limit utilisation higher or making it more difficult to make ongoing payments due to high interest costs. Remember, it is your long term financial goals that should guide your borrowing decisions. Where possible, put money aside and save for your future instead to avoid ever needing to rely on recurring debt.
Good Financial Planning is Key
No matter what kind of debt you take, you need to make sure your debt payments will remain manageable, even if your circumstances change. Take your time at the start to understand how much interest you will pay and what that will mean for your finances.
Avoid missing payments to keep your credit report healthy and maintain access to loans at lower interest rates in the future. If your circumstances do change, always speak to your lender as they will have a range of tailored support options that will be available for you and that will prevent any debt from spiralling out of control. Speaking to your lender is free and will not affect your credit file.
By borrowing responsibly and diligently paying off your debts, you can use debt as a tool to improve your financial future without falling into the trap of persistent credit card debt or unnecessary personal loans.
So, when is it a good idea to go into debt? Borrowing for things that improve your life, such as buying a home, investing in education or starting a business, is generally considered smart. But always be mindful of good and bad debt. By staying informed and managing your debt payments wisely, you can use debt to your advantage without letting it control your future.
