Types of debt : Good debt vs Bad debt

Is there such a thing as good debt ?. Previously I would have answered a resounding NO to this question as I have always avoided debt like the plague.

However, through experience and knowledge over time I have taken on debt in various forms and now feel I can define two types of debt : Good debt and Bad debt.

Good debt

Generally good debt should be strategic and part of a long term sensible plan. It should be clear, manageable, cheap as possible (interest rates), provide opportunities and be affordable to repay.

In a nutshell good debt should be an investment.

Let's look at some examples of good debt.

Investing in your business

Businesses are a great way to generate money but you don't get something for nothing in this life. Therefore, depending on the type of business you are going to start you may need some initial expenditure. This could be for equipment, premises or staff etc and will get your money making machine up and running. There is a saying that you have to 'spend money to make money' and a business is a prime example.

Any kind of debt should always be treated with caution as it can be a fine line between success and failure. If you are going to take out a business loan make sure you have a solid business plan and all of the skill, drive and determination to make it turn a profit. If you get this right you can repay the loan and everything else you get to keep.

Student Loans

Student loans to pay for University can be very beneficial for your future. Graduates generally get paid more than non-graduates so a university degree is definitely worth pursuing. Many would agree that 5 years to repay a loan is a small price to pay for a 45 year high earning career.

Much like the business loan you have to be careful. Only borrow what you need, don't waste money and make sure you work hard and get a good qualification. If you can save some of your student loan to act as a deposit for a property even better !.

Mortgages

Rental prices are increasing all the time and is effectively 'dead money'. The beauty of a mortgage is that not only does it give you a roof over your head but once the loan is repaid it also gives you a huge financial asset. Property appreciates over time so your money is making more money which is great especially coupled with the fact that your mortgage payments are still likely to be cheaper than paying rent.

Home improvements

Now this item won't feature on most lists under good debt because it is a broad category that can mean many things. In my definition borrowing money for home improvements means two things : Finding a zero (or close to zero) per cent credit card or loan and making improvements that are long term.

Examples of this are as follows :

• Structural work which are essential for the property to be safe e.g. rewiring and plumbing
• Long term items which make the house livable and comfortable such as carpets, sofa, heat efficient doors, new bathroom and kitchen. As a rule ask yourself 'will I still have this item in 5 years?'.

Not only will this improve your life short and long term (a key characteristic of good debt) but it will add value to your property which is money in your pocket.

Like with all the good debt just make sure you can afford to repay it in a time frame that works for you.

Bad debt

If good debt is strategic and part of a long term sensible plan then bad debt is the opposite. With good debt we invest in the short term and in appreciating assets whereas bad debt places us in deficit with little or no future return.

Here are some examples :

Car loans

Other articles I have seen say that car loans can be good debt if you can afford it and is a statement I completely disagree with. Cars are DEPRECIATING assets and will always result in a loss 5 years down the line. I personally have always saved and purchased my cars cash which hasn't given me the best cars in the world but when my circumstances have changed I never had to worry. Knowing that no-one had a claim over your means of getting to work or running essentials errands is very reassuring. Car loans act as a compounded loss because not only is the car's value depreciating you also have to pay the loan amount back with interest. It is lose-lose.

Clothes

Unfortunately I have witnessed many people end up with financial problems due to spending excessively on clothes and fashion accessories. Not only do these items wear out in short period of time but some remain in good shape but simply fall out of the latest fashion trend and therefore are no longer wearable. The sad reality is some people are still losing a portion of their monthly income for outfits they wore briefly 4 years ago.

Home fashion items

Home improvements are good but home fashion items are bad if your paying for them with credit or loans. Ornaments, fashionable art and soft furnishings etc look good now but they will be out next summer when you want a fresh look. You may throw these out but the debt remains.

Borrowing money to pay regular bills

I implore anybody who is using money to pay living expenses (bills) or other credit commitments to contact debt management organisations for advice. These are free and have been setup to help people that are caught in this difficult and distressing situation. For those that are contemplating short term or 'pay day' loans please also utilise these organisations as these short term schemes are designed to dig you further into long term debt while giving you short term relief.

Holidays

These are the worst form of bad debt probably owed to the fact they have a specific time limit. For that 1 week holiday you could be paying for it for 3 years. If you want a holiday each year and use debt each time to pay for it, you are subscribing to a life of money worries.

Hopefully this article has shown that debt can be good and bad. If you are careful you can make debt work for you in a positive way and enhance your life or alternatively it can work against you.  So understand the risks, make sure it's affordable and always read the small print.

If you found this article helpful or would like to share your thoughts on the types of debt mentioned, please leave your comments below.