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There is a lot of stigma surrounding debt. Phrases like "falling into debt" or being "saddled with debt” are often used, which paints it in a negative light.
While all debt can be harmful if it becomes unaffordable, it’s just money that you owe someone else.
Some debt can actually be helpful and allow you to increase your wealth and improve your quality of life. Determining whether debt is good or bad can be subjective, depending on your financial situation.
Let’s take a look at the different types of debt and what they can mean.
Good debt
Sometimes borrowing money is essential to achieving important life goals. When you borrow money strategically, this debt can have long-term benefits. Some situations where debt can be good are:
- Education:
Investing in education often leads to higher earning potential and an improved quality of life. Student loans can be a smart move, as higher education can increase job prospects, stability and long-term opportunities. - Buying a home:
A mortgage allows many people to buy a house, which can be a great long-term investment. Over time, homeownership can build equity and provide financial security, along with the emotional benefits of owning your own space. - Starting a business:Borrowing money to start a business can be rewarding both financially and personally. While it involves risks, a successful business venture could provide financial independence. Careful planning is crucial to avoid the high failure rates among startup businesses.
Bad debt
Debt becomes detrimental when it’s used for purchases that don’t retain or grow in value. Borrowing for non-essential, depreciating assets, and being unable to pay them back, can lead to financial strain. Some examples include:
- Cars:
Although necessary for some, cars lose value rapidly. If you can’t afford a car outright, consider alternatives like public transportation, second-hand vehicles or opt for loans with low interest to avoid unnecessary financial loss. - Clothes and luxuries:
Buy Now Pay Later schemes encourage debt for items like clothes, which quickly lose value and appeal. Similarly, borrowing for luxuries like holidays or high-end electronics can leave you paying more in interest than the items are worth. - Payday loans:
You should avoid quick cash payments like Payday loans and finance plans with high interest rates. If you fall behind on a payment, you can quickly accumulate a much larger amount and they can also negatively impact your credit score. This can make it more difficult to take out other loans, like mortgages.
When it’s not so obvious
Sometimes, the line between good and bad debt isn’t clear. Debt may be manageable or even beneficial for wealthier individuals, while for others, it might be a dangerous risk.
This can include debt consolidation loans, which help simplify and manage debt. Debt consolidation loans combine multiple debts into one payment with a potentially lower interest rate. While this can make repayments easier and improve your credit score, it’s not without risks. Missed payments could result in losing assets or damaging your credit further.
Final thoughts
Debt can be a powerful tool if used responsibly, but it can also lead to financial hardship if mismanaged. Always assess your ability to repay before taking on debt, and consider seeking free, independent advice from organizations like StepChange or Citizens Advice.
