Good debt v bad debt

Debt is often thought of as something bad we should all try to avoid. And there's no doubt that this is true of certain types. But you may find there are some types of debt you may take on in your life, like a mortgage, that as long as it's manageable, doesn't necessarily need to be considered bad.

Good debt

In simple terms, a good debt is one that is a sensible investment in your financial future and should leave you better off in the long-term without having a negative impact on your overall financial position.

To qualify as 'good' debt, you should have a clear, manageable and realistic plan to pay it back, whether that allows you to pay back the debt as quick as possible, or in manageable chunks (like a mortgage) and it should be affordable to you, at the time you incur the debt.

To be a good debt, you should also have thought of the cheapest way to pay back your debt. This may be the option with the smallest interest rate. You should take any additional interest, charges and penalties that you may incur through payment holidays or under and over payments into account in your affordability calculations.

Examples of potential good debts include student loans; mortgages; investing in your own business; and buying a car, so long as that car is affordable to you.

Bad debt

Bad debts are, in essence, the opposite. They drain your wealth, are not affordable and offer no real prospect of 'paying for themselves' in the future.

They are likely to have no realistic repayment plans and are often the result of impulse purchases or borrowing money to cover everyday spend, like bills.

A good indicator of whether something is a bad debt is to consider whether you can afford to borrow the money. If you aren't sure whether you can keep up with the monthly repayments, it's likely to be a bad debt.

Examples of bad debt would include a luxury holiday or brand new car or borrowing in order to pay your bills, that would stretch your finances to breaking

Always ask yourself if borrowing the money makes sense for your finances in the long run and if there is a better way to borrow for your situation.

What to do if you're in bad debt

If you are struggling with bad debt and want to know how you can balance your finances, the first thing you should look at is how to prioritise your debts. Priority debts are ones which carry the most serious consequences for not paying them, such as losing your home or having your heating and lighting cut off because you haven't paid your fuel bills.

Non-priority debts include things like bank loans, overdrafts and credit card debt. Although it is still very important you pay these off, they are not the biggest priority.

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