What can you expect to learn in the debt repayment 101 series?
Key Outcomes: Healthy credit score, improved credit score, debt-free, healthy personal finance, stress-free finances.
When used responsibly, credit can be a helpful financial tool. Whether it’s taking out a home loan, securing financing for your business, or buying a car with manageable repayments. Access to credit can also help you deal promptly with unexpected, costly emergencies and can offer peace of mind when travelling.
But, when not managed correctly, credit can also lead to crippling debt. Getting rid of that debt is a big mission!
Debt repayments can seem like an insurmountable task, but there are clear and effective strategies to manage your debt and the process of repaying it. We’ve got everything you need to know in our debt repayment guide so that you manage those outstanding amounts with ease
Ready to get started? Let’s get going below.
Shortcut to the articles in the debt repayment 101 series
Article 2 – Understanding Good vs Bad Debt
Outcome: Before repaying debt, it is important to better understand debt, the words we use when talking about debt, and how you get caught in a debt cycle.
While debt is something that should be avoided, there are real situations in life that require certain credit to be taken. This is where the difference between ‘bad’ and ‘good’ debt comes into play and should be understood.
1. What can be considered as bad or unhealthy debt?
As a simple definition, bad debt can be explained as the type of debt that will prevent you from building wealth and healthy finances during your life. If you are using credit to buy something unnecessarily or purchasing something that has little value after its initial sale, it can be considered ‘bad debt’. This ‘bad debt’ is usually associated with expenditure on credit cards, at retail stores, and for lifestyle purposes. For example, if you borrow money to buy clothes you don’t actually need, that is bad debt.
Bad debt can come in many forms, as there are many ‘unhealthy debts’ which can reflect negatively on your credit score. You should always try to avoid borrowing money to buy consumable items (clothing, food, electronics, etc), to help pay off other debts (don’t borrow money to settle another debt), or make an investment (never invest money that isn’t yours).
While debt is common, there are ways to manage and avoid it in the long run. However, if you neglect the money that you owe or spend unnecessarily, this type of recurring debt can prevent you from ever building wealth, buying an important asset, such as a house, starting your own business, and creating a healthy financial future for yourself.
When it comes down to it, bad debt can be very subjective. None of us can tell a parent who has no food or clothes for their child that they should not buy it with limited credit they were able to access. But, essentially some of the examples above are what can be considered as the type of debt that will prevent you from building wealth or healthy finances during your life.
2. What is good debt?
And this is where ‘good debts’ come in, as not all debts are considered unnecessary. ‘Good debt’ refers to money borrowed for productive or wealth-building assets, such as home, student, or business loans. If you get a home loan or borrow money for your education, this can be thought of as ‘good debt’ as it usually helps you build a healthy financial future – when used responsibly. That doesn’t necessarily mean that you must borrow money for these things, but they are more acceptable than borrowing money for needless purchases.
These ‘good debts’ are often seen as a positive reflection on your credit history, as it showcases that you prioritise assets, education, and wealth, compared to quick spending.
The flaws in our credit scoring systems are clearly seen when it comes to needing to access these types of debts. They have huge barriers of entry, such as rigorous credit checks, deposits, and long-term agreements. Ironically, if you need to build a credit history, the quickest way of doing it is to incur a bad debt. Over the long run, when you access credit for something like the purchase of a property or vehicle, it is seen as a positive sign of your affordability and creditworthiness. This represents whether the banks trust you to pay back your debt or not.
3. Is there really such a thing as good debt? A matter of perspective
With that said, while these types of loans are referred to as ‘good debts’, there is the idea that no form of owing money to anyone else should be considered positive.
For example, some people see a car loan or a home loan as good debt, because you’re paying off something that has value and can be resold. However, many believe that buying things cash is the only option, and any type of credit should be avoided wherever possible.
This is because even these types of ‘good’ assets depreciate that lose value. Cars get old and damaged, and houses can have maintenance issues. Furthermore, you still owe someone money following the purchase of a car or home, which is a cost burden for you to pay off.
So, what’s the solution? The concept of a hybrid approach is seen as more acceptable nowadays. The saying of “never live beyond your means” applies here. If you can afford it in cash rather than credit, then do so. However, if it’s a sizable purchase, like a house, and can afford a down-payment, then buying it is a good investment, as you’ll be paying rent anyway. Of course, your cash flow is important in making these decisions, as you’ll need a solid budget in place and a savings plan to anticipate any unforeseen costs along the way.