Good Debt vs Bad Debt
Most of us will, at some point, have a certain level of debt. But, debt is bad, right? Although this is largely true, a point often overlooked is that some debt can actually be a good thing.
Even so, some will argue that any debt is not good but, for millions of people, it is the only way they can get on the housing ladder or further their career. (Although, it is worth remembering that too much of either debt can work against you.)
While perceptions of good debt and bad debt can be oversimplified, the fundamental basis is simple. Overall, good debt should help you achieve future financial gain while bad debt will expressly worsen those same goals.
Our debt-to-income ratio will help you understand your debt level in a simple way. Your DTI is your monthly debt repayments, divided by your gross monthly salary. This total shows lenders, at a glance, how well you manage debt.
These good or bad types of debt will influence the score on your credit report and your access to a loan. However, organizations like The Payday King can help when you need it the most, and importantly, all credit scores are considered. Click here for a free quote……
We have simplified and categorized good and bad debt for you in the following table:
What is Good Debt?
Specifically, good debt is money that you owe that will, over time, likely increase your income or your wealth in general. This form of debt tends to be long-term and has low interest repayments. Examples of good debt include the following:
Mortgage – this is widely considered as one of the safest forms of debt. For the majority of people with a mortgage, buying a home that increases in value over the term of the loan will put equity back into the house. Ideally, monthly repayments should be no higher than 36% of your gross monthly income.
Student/college loan – student loans are an investment in your future by allowing you to further your education and increase your earning potential! Furthermore, your future salary will doubtless outweigh the loan itself. Aim to take a loan out no higher than you anticipate your first year’s salary will be to allow for comfortable monthly payments over the next few years.
Business loan – a small business loan can help further your enterprise. Although it can be hard work, running a successful business can be very rewarding and those rewards aren’t only financial, but mentally too.
What is a bad debt?
Bad debt is a debt that does nothing to increase your financial situation or financial goals and could actually deplete your finances. This type of credit tends to have high interest rates and, when managed badly, will have definitely have a negative effect on your credit score.
Personal loans – personal loans can be seen as bad debt because they tend to be spent on things that won’t generate more cash for you, such as clothing, vacations, the latest gadgets, or a night out. This spending is seen as a waste of money and the ease of getting a quick loan may make you want to do it again rather than save for those things.
Payday loan – if you are already struggling with crippling debt, a payday loan will not help. Due to the higher interest rates, this can make it harder for you to manage. If you are confident that you will have the money to pay the debt by the next paycheck, including the higher interest, then a payday loan could help you out in an emergency. If you don’t have the money and you need to borrow more to pay it or end up with a late payment fee, it can be difficult to get out of this cycle.
High-interest credit cards – as with a payday loan, if you pay off the balance in full every month, the high-interest rate shouldn’t affect you. Although, if you don’t pay it in full, the interest added makes it difficult to clear the balance and the repayments can go on for a long time.
In spite of the examples above, not all debt can be quite so easily defined as good or bad. It may depend on you as an individual – your salary, your credit report, current debt level, and much more. And it can depend on precisely who is deciding whether it is good or bad, as can be seen below.
Car Finance: car finance is viewed differently depending on who is judging it. For some, a car loan is seen as good debt because an auto loan is secured against your vehicle, whereas a personal loan taken out to purchase a car can be seen as riskier.
In other words, you may need a vehicle to help you succeed in your career, and so a car would be indispensable. And by achieving this, it could lead to a salary increase, etc. (Although, it is recommended that the loan term is no more than 4 years and each monthly repayment equates to less than 20% of your monthly salary.)
In contrast, because a car is a product that you spend money on and almost never make a profit on when selling later, it can be seen as a bad debt by others.
Debt consolidation – this can be viewed as good credit because once you get a consolidation loan, you tend to get a lower APR to allow you to meet the monthly repayments over a set period of time. It will be easier to make one monthly payment with a lower APR than numerous minimum payments, some of which may have a high interest rate.
If you spend the money genuinely clearing your debts, this personal loan can work exceptionally well for you. On the other hand, if you spend half clearing some debts and blow the rest on non-essentials, you haven’t succeeded in clearing your bad debt. Your multiple repayments may never go away and, remember, some of these will also have a much higher APR than a consolidation loan. This will certainly be viewed as bad debt.
One more thing you should ask yourself when borrowing money is “Will this debt eventually pay me more than I will put in?” For instance, in due time, will it help you to get your dream job or much-desired promotion? Will the debt enable you to get on the housing ladder? Can you grow your enterprise with the help of a loan?
- If the answer is yes, it is good debt!
- If the answer is no, ask yourself do you really need it or could you save money towards it to lessen the amount you will be paying someone else in interest?
Another key point to remember is that you must also take into account potential redundancy, recessions, or even welcoming a new family member, all of which will put a strain on your finances. None of us can predict the future, so don’t borrow more than you can comfortably afford to repay.
On the whole, not all debt is bad debt, but remember that too much of either good or bad will eventually become a concern. Indeed, you are not being advised never to take out a loan for a car, vacation, or emergency, but you are advised to ensure you can pay it back.
Generally speaking, the majority of us currently have or have had some form of debt and, by knowing which type you have, you can work on improving your financial situation when, or if, you need to.
If you are struggling and need some help financially, we at The PaydayKing will do our best to help you out, taking into account all credit scores and no fees whatsoever to submit your inquiry!