Is all debt bad debt?
In a word, no. In much the same way as there are good and bad fats, there are good and bad debts. And these days it’s almost impossible for us to live debt- free. Not many people can afford to buy a house outright for example – they need a mortgage. However, as property is generally considered a wealth-building investment, this is regarded as ‘good debt’. Conversely, if you borrow money to buy a car, this is an example of ‘bad debt’ because the value of the car drops as soon as you drive it off the showroom floor.
What is good debt?
There are two main types of debt: secured (where you have pledged an asset like your home to the lender – the bank) and unsecured (where the lender does not require any assets as security from you – like a credit card; which is why the interest rate is higher). A loan to purchase an investment property is generally viewed as good debt. Not just because the property is likely to increase in value, but also because it generates regular income – which can be used to pay off the debt or used for other investments.
Bad debt can be OK – in moderation
Bad debt happens when you start borrowing money to fund your lifestyle, or expensive items that will decrease in value as soon as you’ve bought them. It’s easy to get stuck in a cycle of credit-card debt, with high interest payments building up month after month that become hard to pay off. But you can use credit cards to your advantage. They can help manage your cash flow, just so long as you can afford to pay off the debt faster than the required minimum payment. It’s always best to pay off your credit cards in full at the end of each month. That way you will never pay any interest when using the card.
If you find yourself drowning in debt then it may be time to develop an action plan to get the debt under control and pay it off as soon as possible. Check out our debt consolidation article coming soon for some helpful tips.