When it comes to debt, it can be easy to assume that it’s all bad, but in fact, there is such a thing as good debt, and in some instances, it’s even essential, such as when trying to establish a good credit score.
Borrowing responsibly enables you to have the kind of debt that will help you reach your financial goals, but knowing which debts are good and which are bad, is important to understand:
What is classed as good debt?
If you’ve got debt in the form of an investment or purchase that is helping to improve your overall financial standing, then it can usually be referred to as ‘good debt’. Some examples of good debt are as follows:
- • Mortgage loans
When mortgage rates are low, and properties gain in value, you could build equity as you pay down your mortgage and turn your loan into seriously smart debt.
- • Investments
Depending on the type of investment you make, you can generate a healthy income and capital gains, and in many instances, money borrowed for investment purposes is tax deductible. This is almost certainly ‘good debt’.
What is classed as bad debt?
If you make a purchase and the value decreases to below the original cost, or the interest rate is very high, these types of debts become much harder to pay off, and quickly turn into ‘bad debts’ such as the following:
- • Credit cards
It’s true that you must have at least one credit card to establish a credit history, but fail to use it wisely, and you could soon have bad debt on your hands. Carrying a balance on your card and never paying more than the minimum payment every month, is a fast way to pay more in the long term.
- • New vehicles
As soon as your shiny new car is driven off the lot and onto the road, its value will have depreciated significantly, so think carefully before investing a car, lest it become a bad debt.
- • Deferred purchases
Purchasing a large item such as a sofa or widescreen television that doesn’t require immediate payment in full, could see you facing exorbitant interest rates until the item is paid for.
How can you avoid bad debt?
It’s possible to manage bad debt with a little self-control and forethought, and even to avoid it in some instances. Cash advances are never good for your debt situation, and credit cards should only ever be used for buying things you can actually afford; it’s important to pay off the balance in full each month, too.
If you’ve got a mortgage and are struggling to manage your debts, or would like to apply for one but aren’t sure what you’ll be offered with your existing bad debt, meeting with a local mortgage broker can be immensely helpful, and a lot more cost effective than you might think.