Sometimes we may hear phrases like ‘good debt’ and ‘bad debt’ but we are often told that debt is a really bad thing. It can be confusing knowing whether there is actually such a thing as ‘good debt’ and whether it really is good or not.
There are different definitions of good debt depending on who you consult, but there are many people that think that it does exist. It usually applies to things like houses and student loans because the items that the debt is used to buy are worth more than the cost of the debt. So if you buy a home, it should increase in value, so once you pay off the debt and the interest it is worth more than those added together, so you have more value in the property than you paid it. This effectively means that you made a profit. With a student loan it is expected that the education that you buy with the loan will allow you to earn significantly more money and in the UK, at least, you will only have to repay it if you are earning well anyway. This may also apply to other purchases, such as borrowing to repair your home which will prevent further damage that could be dearer to repair in the future or that will significantly increase the value. On the opposing side, borrowing money to buy shoes, when you already have lots of suitable pairs, would be considered to be bad debt. As would borrowing to buy any luxuries that you could manage without, perhaps home accessories, brand new cars when you have a sufficient one already and things like that.
However, some purchases are difficult to classify. Let’s give an example of someone who is unemployed and needs to have a driving licence for a job. If they need to borrow money in order to learn to drive, is this a bad debt? If they get the job they will be earning so they will be able to pay off the debt, but it is risky as they may not get the job. However, the skill of being able to drive could help their prospects of getting other jobs. It is rather difficult, in this situation to classify whether this would be a good or bad debt.
Others classify good debt as well researched borrowing. This means that the person borrowing the money has made a calculated decision as to whether borrowing is the best thing for them to do. They have used sites to find the type that suits them the best and looks at costs to find the one that is the best value for money. This is certainly a very sensible approach. You want to make sure that you are not borrowing unnecessarily and certainly not borrowing more money than you need to or paying more than necessary.
It is probably best to think about good debt in both ways. So try to only borrow money which will enable you to buy things that will help to improve your future. Then make sure that you really need to borrow, borrow as little as possible as cheaply as you can and then you are getting the best possible deal. It is also wise to keep a close eye on rates to make sure that you cannot get a cheaper loan anywhere else as you may be able to switch lenders and benefit that way. Do watch out for hidden charges such as administration fees for setting up accounts and early redemption fees.
So there is such a thing as good debt but whether a debt is good can not only depend on the type of debt and the planning and research done when taking it out but your own personal circumstances. If you are not in a position to cover the repayments on the debt, then this would be bad debt. It would not take long before you got into trouble for not making the repayments and you could end up being prosecuted. So you do need to think about how you will repay. Consider what money you have coming in and going out and how you will make more money available to cover those repayments. It is also wise to think about how you would manage should your circumstances change. What if interest rates were to rise, your income were to fall or your spending to go up. Consider where the extra money would come from to cover the repayments on the loan.