Debt, for many people and households, is not simply a fact of life it is a way of life.

Debt is used to pay for everything, the bigger the item, such as a house or car, the more likely a household will use debt to finance the purchase. Is there a distinction however between ‘good debt’ and ‘bad debt’?

‘Good debt’

      1. Education: debt used to fund education. A typical university leaver will have approximately £50,000.00 in student loans and debt by the time they finish university. However, this debt will in most cases be used to enable the debtor to find employment in higher paying jobs and career opportunities. It can also enhance the debtor’s self-worth and confidence. Consequently, this debt could be argued to be a good debt as it enhances that person’s self esteem and career prospects.

      2. Small business ownership: debt can be taken on by entrepreneurs to finance their business to hopefully increase their earnings potential and grow a business.

      3. Property: most people have a mortgage which is a debt that enables someone, or a couple to buy a property. This property will most probably grow significantly in value while it is being lived in and will be sold years later at a (tax free) profit. The mortgage debt has enabled that couple to make money on their residential home and it can therefore be described as an investment. Similarly, mortgage money can be secured to invest in other properties commonly known as buy-to-let properties and it is possible to make a profit from the rent achieved on those properties and also capital growth on the property in the longer term. Again, the mortgage debt can be seen as an investment and therefore a good debt.

      4. Investing: a person can go into debt in an attempt to generate income and wealth from investing in stock market based investments or even riskier investments such as precious metals or futures. If money is made this is consequently an investment, albeit significantly riskier than the previous investments described above.

      5. Rolex watches: a bit of a ‘leftfield’ call but if you buy any Rolex sports model watch such as a GMT Submariner or especially if you buy a stainless steel Daytona then wear it for 10 years you will almost certainly be able to sell it for more than you bought it for. Should you wish!

It must be said that there is no guarantee that the debt taken on can be classified as worthwhile and a ‘good debt’. For example, the student may not go into a career which is higher paying than he would have done otherwise. The small business may fail and there may be a housing crisis or crash.

‘Bad debt’

If it will not go up in value or generate an income, you shouldn’t go into debt to buy it. Some examples of ‘bad debt’ include the following:

  1. Cars: Cars are depreciating assets. This means that as soon as you buy one it will go down in value, often quite significantly. The more expensive the car the more money you lose. Unfortunately, the debt you take on to pay for or finance the car does not change or reduce in line with the car. Again, unfortunately, most people have some level of vanity when buying a car and will insist on a car with a notable brand name and ‘all the bells and whistles’ added on to it. If you can, put your ego aside and buy the least expensive reliable vehicle you can and pay it off as quickly as you can getting out of debt.

  2. Clothes, consumables and other goods and services: clothes are similar to cars in that they are worth even less after they have been bought than a car. In fact, as soon as they are bought, clothes are virtually worthless second-hand. If possible, therefore do not use debt to finance clothing purchases. Similar principles apply to other consumable products and services such as holidays. Keep your debt spending on these items as low as possible at all times.

  3. Credit cards: they are a particularly bad debt. The interest rates charged are significantly higher than most other types of debt and interest rates paid on a credit card each month is simply dead money.

It may be possible to take out a consolidation loan to pay back debt at an overall lower rate of interest. Similarly, a debtor should always look to see if the debts can be restructured, perhaps through an insolvency procedure such as an Individual Voluntary Arrangement or Bankruptcy.

Conclusion

It is possible to argue that no debt is good debt. However, as outlined above it is certain that some kinds of debt are definitely better for your finances. It must however, be always remembered that even ‘good debt’ has a potential downside and risk.

If you would like to speak to a specialist insolvency and debt solicitor about your finances, please call on 0845 287 0939 or email today.