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The Difference Between Good Debt and Bad Debt

Not having enough money and getting into debt can be a stressful experience. Many people don’t consider it sensible to borrow money, however, there’s a difference between “good” debt and “bad” debt, and at times, borrowing money may have more positive consequences than you might think.

Good and bad

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The key is working out if borrowing money is the best thing for you, depending on your personal circumstances and the reason you want to borrow it.

 

Good debt

The thing about good debt is that it should leave you better off in the long term. It should help you to manage, or improve, your financial situation, saving money over time and making your life easier.

One example is spreading costs. If you have savings, it may not be realistic to use them for a large and unexpected cost, such as needing a new boiler. You may not feel comfortable being left with no money if you spend your savings on an expensive necessity. Credit can be a handy way to pay the costs over time.

You will probably have to pay interest, so it will cost more, but you will not have delved into your savings, so you won’t have struggled with a large one-off expense, leaving you short of money. Paying off the loan monthly is unlikely to have the same crippling effect as suddenly having to pay out hundreds of pounds in one go.

Another example of good debt is travel costs. For example, if you travel to work by train every day, it can cost, on average, around £7,000 for day tickets over the course of 12 months. However, if you buy the annual season ticket, it costs only around £5,600.

If you take out a loan to buy a season ticket and pay it back over a 12-month period, the average interest cost will be around £350. This means by going into debt to take out the loan, you will still have saved £1,050!

 

Making sensible investments

Other examples of good debt include taking out a mortgage to buy a property. Your home is likely to increase in value over the years, even allowing for dips in the market when the economy isn’t great. Many see a mortgage not as a debt, but as an investment.

Your initial investment in the mortgage will probably be worthwhile, because at the end of the repayment term, or possibly before then, the value of your home could surpass the cost of the loan. If you get the right price when you sell, you can make a tidy profit.

Other examples of good debt to invest in the future include student loans. Although nobody likes paying for education, it is a necessity today. In doing so, when you attain your degree or other qualifications, it will increase your earning potential significantly.

Taking out a business loan in order to launch a new company, or grow your existing one, is also an investment. Even though it’s a debt, it is giving you the potential to make more money in the longer term, depending on the future success of your business.

 

Building your credit score

Building your credit score by managing a credit account properly can also be useful. When you have a bad credit score, it can mean not even being able to open a high street bank account with a debit card.

Many people with poor credit rely on pre-pay Mastercards, or banks that charge a monthly fee, because a regular bank refuses their application. They need a bank account to receive wages and benefits and to pay bills, but their poor credit history holds them back.

If you manage a credit account properly, your credit score will recover and improve over time. Staying below your credit limit and meeting the repayments on time will keep you on track.

 

Affordable debt

Good debt should be affordable and will not damage your overall financial position. When you take out a loan or a credit card, making the repayments should not take money you put aside for your mortgage, rent and bills. Neither should it stop you from putting money aside for your long-term goals, such as saving for a mortgage deposit, or for a private pension.

Try to ensure you can meet the repayments until the debt is repaid. For example, if you’re in temporary employment and you know your contract is due to end, there is no point in taking out a loan based on your current income.

 

Bad debt

Bad debt will leave you worse off and drain you financially over time. It can be something as simple as making an impulse buy on credit, such as a store card or catalogue account. It can be purchasing a luxury item that loses its value quickly.

Bad debt will waste your money in the long term. It will make you live on a shoestring budget to ensure you make the repayments and you will feel you’re throwing money away.

It becomes unaffordable, and can lead you into a vicious cycle of debt, if you’re taking out a credit card just to pay regular household bills, or you’re unable to buy necessities because much of your income is tied up in debt repayments.

This is bad not only for your financial security, but also for your physical and mental wellbeing. Nothing is more draining than continually being in debt and realising you don’t have enough money for your everyday essential needs.

It can lead to defaulted accounts, when a lender closes your account and may take legal action against you for non-payment of the debt. Your credit score will deteriorate further, the more missed payments or defaults you incur.

It can affect your quality of life and make it difficult to get accepted for credit in the future, including for things like a contract mobile phone, or car insurance on monthly instalments. All of this can mean a poorer quality of life.

The best thing to do, if you’re considering taking out a loan or credit card, is to ask yourself some simple questions. The main one is whether you can meet the repayments comfortably. Check whether the interest rates can rise, potentially making it unaffordable.

If you have a clear, specific and important reason for borrowing money, this is more sensible than borrowing just so you can splash out on an item you don’t actually need on impulse. Be realistic and decide whether something is worth getting into debt for.

If you need to borrow money urgently in an emergency situation, it could be worth looking into short-term loans to help you get through a challenging time. Securing finance against your vehicle with a responsible lender, such as Logbookloans247, is one option for raising cash quickly.

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