If you, like many others, have done a quick Google search on “what is the difference between good debt and bad debt” – you’ll have received tons of overwhelming information on the topic. So we thought we’d help you along your way by distinguishing between good vs bad debt

For young people entering the workforce, it’s difficult to understand the information in their own context. This usually results in a young working population getting into the wrong types of debt, instead of being enabled to build the future of tomorrow.  

In this article, we have a real talk about good vs bad debt. We break down each scenario and aim to help you as a young professional build a healthy financial future!  

What is debt? 

Debt at its most basic is money you’ve borrowed. And, when we refer to it further down, we mean debt you acquire from a lender in the form of a loan or credit card. The condition of debt in most cases is that the money will be paid back at a later stage. The terms of a loan usually include an interest rate as well as a loan repayment period.  

What is “bad” debt? 

This is debt that doesn’t assist your financial health, and typically is something you cannot afford to pay back. It is debt you collect in order to purchase a depreciating asset. Bad debt itself can still have both good and bad in certain contexts. It can be good if your accounts are paid on time, and in turn affect your credit score positively. Or, it can be bad if you collect lots of debt and fail to pay it back. However, in its entirety, it’s still not debt that is going to help increase your net worth as it’s a bad return on investment.  

Examples of bad debt: 

• Vehicle finance – we know this could be an asset in South Africa – with the need for personal transportation. However, the moment you leave the car dealership your car loses value, and in addition to that, you’ll need to pay car insurance.  
• Excessive store accounts – starting out in the workforce you probably need a new wardrobe, and what better way than by opening a store account at Woolworths or Edgars.  Clothes and consumables are not worth very much at all after you’ve paid for them, especially clothes. Sure, opening up one store account for clothes you would have bought can be a good idea for building a credit score. But one at each major retailer will quickly take you where you don’t want to go. 

What is good debt? 

Simply put, good debt is the debt that adds value to your life by enabling your future or helping you to create opportunities. You can, however, have a shortfall on your good debt which in turn impacts your credit score negatively. It’s still important to note that any debt no matter how small it is can become bad debt.  

Examples of good debt: 

• Student loans – these are generally low-interest loans, and it’s an investment for your future earning power. The penalty is often far less on a student loan when you’ve missed payments.  
• Business loans – if one day you own a business, taking out a loan to increase sales directly affects your financial future. However, with this there is a great risk if you fail to pay back your loan, you risk the livelihood of yourself as well as your employees.   
• Home loans – a house is a great asset, as you can invest time in buying, fixing up and selling your house at a later stage. Also, once this loan is paid off it can be used as an asset against a future business loan.  

So what does this mean for young professionals? 

There are plenty of new choices and decisions you’ll need to make on your own as a young professional. The biggest life change will be financial freedom in the form of income (yay!).  

But, with great power comes great responsibility – income tax and credit card repayments – but we will stop raining on your parade. 

Unfortunately, money coming in isn’t always that well-spent. And for most fresh graduates – healthy spending habits weren’t quite part of your university curriculum. We know for a lot of you starting out in the working world there is overwhelming pressure on how to spend your money. And unfortunately, this is what leads to debt. If you aren’t still worrying about paying off your mountain of student loans, you’re now worried about paying your rent, insurance and electricity each month.  

The debt trap is a very easy one to fall into, South Africans spend 75% of their take-home pay on debt. DebtBusters reported an 18% increase in debt counselling in 2021 compared to the same period the previous year.  

With the above statistics in mind, let’s dive a bit deeper into understanding bad debt vs good debt in South Africa for young employees.  

Stay tuned further down for  5 valuable tips to help you manage the fine line between good vs bad debt in South Africa. 

Whether you’ve accumulated Good Debt or Bad Debt will depend on your individual situation.

These are the factors that can contribute to the type of debt you have:  

• Type of job 
• The reason behind taking the job 
• your employment agreement (permanent, contract or temporary employment) 
• marital status 
• dependants 
• remuneration and benefits 
• whether it is long-term or short-term debt  

There are a number of different things that will determine whether you fit into the good or bad debt category. However, at the end of the day, debt is debt, and the most important thing to remember is the consequences of it. The thing you should be mindful of most is probably the interest rate on your debt.  

Let’s talk about interest rates 

It’s valuable to educate yourself on the varying interest rates for different types of loans. For instance, student loan interest rates are much lower than credit card and personal loan interest rates. These products are very popular in South Africa, especially for young workers. Unfortunately, there is very little education on how interest rates work on the different products. 

The repayment terms for student loans are more accessible with fewer consequences when you miss payments compared to Credit Cards, Vehicle Finance and Home Loans. There is a large gap between the loans targeted at students vs those at young adults, and often first-time workers aren’t prepared for the full impact of debt and the consequences that come with that.  

That’s why finding a finance education tool like Fincheck Academy is so valuable when trying to understand the jargon involved or for example something more specific like – what are the best banks for low-interest personal loans.   

The reality is, debt will likely form part of your life in some shape, form or size at any given time in your future. Before taking on debt, it is crucial to understand how to calculate interest rates and what the implication of interest will be on the total amount you pay back. You can head to Fincheck Academy’s loan repayment calculator page to get an idea of what this would be.  

So how can you change your financial mindset?

There are a number of decisions you can make that will impact the rest of your financial future and improve your credit health.  

If you’ve just started working in an entry-level position or aren’t earning anywhere near what you’d like to be, unfortunately, there can still be a lot of things on top of this pressure you need to take on financially. A couple of examples of expenses that can contribute to your debt: 

• taking out an apartment lease in your name  
• buying a new car 
• getting married  
• taking care of your dependents  
• keeping up with your new lifestyle 
• external expenses you’ll need for your job – new clothes, personal laptop, internet contract.  

These ever-increasing expenses are difficult to manage on a basic or entry-level salary, and this is why young professionals take out loans.  

Is it bad to take debt? How do you determine good debt?  

Yes, we know you are probably still trying to wrap your head around debt. But before you decide whether you need financing or not, you need to define what your financial future is going to look like – meaning what are your goals professionally and personally. You also need to decide whether taking out any sort of loan at this stage is feasible. 

For instance, if you are employed on a temporary contract, a personal loan, a payday loan, and buying a car or a home can all be irresponsible financial decisions as you won’t have the security or stability of knowing you’ll be able to pay them off.  

If you are in this position, rather save a portion of your monthly income until you’ve got enough savings to fall on. Another option is to pay off any short-term loans or student loans you might have. 

What are safe types of debt? This can include monthly subscriptions and contracts e.g., cellphone contracts or your DSTV account. But, if you fail to settle these accounts on time, it will decrease your credit score and negatively impact your credit health (we’ve got you covered with a credit health course if you need assistance)   

Here are some important questions to ask yourself before you take out any more debt?  

• What do I need the loan for?  
• How much do I NEED to borrow?  
• Where are you going to live?  
• Can you afford a car?  
• How far are you going to travel for work?  

How do you go from an unknowing student to a savvy working professional? 

We’ve all been there before, strict budgets and living month-to-month are synonymous with student life. So how do you make the leap into the workforce?  

Unfortunately, the financial temptations are going to be even more overwhelming the more you earn. With 23% of South Africans having no money left at the end of every month, you can see how easily you can be swayed into opening a store account or taking out another credit card. However, the underlying issue in South Africa is the failure to communicate how much it is going to cost in the long term.  

A big problem comes into play when you miss a high-interest repayment, every time you miss these payments it pushes you one step back in improving your credit health. Oops, now you’ve gotten to the stage in your life of applying for a home loan or vehicle finance, but your bad credit score prohibits you from doing this.  

What is the solution?  

It’s time to simplify, cut out the unnecessary and make better financial decisions that reflect where you are in life right now.  

 “Keeping Up With The Joneses” is the behaviour you really need to watch out for, as this is what can really put you in a bad debt cycle.  

This behaviour usually comes with the initial excitement of getting your first salary and having the financial freedom to decide what you can spend money on. If you try and keep up with those around you when you can’t afford it, you tend to collect an unnecessary amount of debt you can’t pay back.  

We could give you a list of ways to combat this behaviour but it all comes down to being content with what you have. If you really want to splurge or spend money on things you want – save up and buy it debt-free when you can. If you are already in the worm whole of this bad behaviour you can catch up by putting together a smart repayment strategy.  

An example of this would be if you want to buy your dream house debt-free you would need to plan for your future and make smart decisions so that you can live your life financially independent. This means creating a balance between your available cash flow and the amount of debt you shoulder. You can use these tips to get the debt balance right. 

5 tips for balancing the line between good vs bad debt 

Tips for young employees to live a financial-burden free and balanced life: 

1. Create a budget you can stick to 

This will probably evolve over time as your income and expenses do. But getting this step in place will set you in the right financial direction. If you are in need of a simple monthly budgeting tool use this one to help you along your way.  

2. Track every little and BIG expense.

Create an excel spreadsheet or logbook, take note of all of your expenses and track your cash flow as this is vital for your financial health. Our simple cash flow tool will help you do this.  

3. Prioritise debt

“First things first I’m a realist.” Sometimes we’ve got to take advice from musicians when it comes to our finances. Get to the most urgent debt first. Your interest will snowball if you delay your debt repayments as credit facility companies add interest upon interest for any late payments.  

4. Get on the savings train

Whether it’s money for an anniversary or for your child’s first birthday party – it’s always important to have savings. Setting yourself financial goals like this means you will be able to carry some of the weight instead of putting more debt on your shoulders. 

5. Live within your means

 It’s very easy to get caught up in it all when you’ve just started working. However, the truth is, it’s most likely that you can’t afford to eat out every night.  Focus on practising financial discipline, if you are going to take out debt make sure it’s good debt – things that are going to catapult your career or investments. Bad debt in South Africa is an easy trap to fall into with stores offering amazing incentives to open up accounts. You do not need the latest iPhone or Country Road bag, but you do need to create a financial future you are happy with.  

Bonus tip: Make strategic credit choices.  

First, check your credit score, so you know what your financial position is.  Avoid high outstanding balances and unsecured loans, as these can both be risky business. If you miss a payment on these types of debts, the interest can quickly cripple you. Tackle the big debts first, set yourself a savings goal and manage your small debts smartly. 

Sjoe that was a lot! To sum it all up, you need to look at your financial goals, where you are currently and where you want to be in the future. As a young professional avoid unnecessary debt wherever possible, take on good debt when you can and live according to your budget.