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Understanding Debt: Good & Bad Debt

Being smart about debt is vital to having a healthy flow of funds into wealth creation. A diet of bad debt drains your financial health, but good debt can help keep finances fit for the future.

Before you can work out which debt diet you are on, or if it is a mix of the two, make sure you understand the difference between good debt and bad debt.

Good debt

Good debt is debt that over the long term can help you create more wealth. It does this primarily by giving you the financial capacity to invest in assets that have the potential to grow in value, like shares or your house. It could even be a student loan that funds university studies which can help increase your earning power in the future. Some good debt can be even better when your borrowing costs are tax-deductible, reducing the overall cost to you.

Bad debt

So-called bad debt usually ends up being channelled into non-wealth creating uses. It could be through car loans, personal loans or credit cards used to acquire short-term goods that are likely to depreciate, or to meet everyday expenses.

It can be easy to let debt take on a life of its own. It is also just as easy to view it as a priority and take the time to keep it in check with a few simple strategies.

Five strategies to keep debt in control

Budget – Lock in a budget that’s realistic, practical and one that you know you won’t have too much trouble sticking to.
Consolidate debt – Don’t just think about what’s good about your debt profile and what leaves you doubtful. Reorganise it by bedding down loans with low interest rates that are easier to pay off. Make sure you check the period of the new loan first – you may end up paying more over the long term. Also, resist the temptation to tap into any credit cards or overdrafts you eliminate with your debt consolidation.
Regular automatic payments – Set up direct debit, or automatic payment plans that can gradually whittle away your debt.
Pay cash – Where possible, use cash to buy things. It can make you think twice about whether you really need it.
Write down what you spend – When you see it on paper, it might shock you into channelling your cash elsewhere.

Your debt questionnaire

Getting the right system in place is often simply a case of reassessing your attitude to debt. Here is a quick checklist of questions to get you thinking about how healthy your relationship to debt is:

  • What are your financial circumstances?
  • How do you and your partner view money?
  • Can you shift from being a spender to a saver?
  • What do you want from your money, long term?
  • Is it time to minimise bad debt?
  • Can you repay debt more quickly?
  • Are fees from credit card reward schemes costing you money?

Managing debt is all about making debt work for you, not against you, and recognising that it’s not too difficult or time consuming to reassess your approach and change it.

If it’s all too daunting, my money coaching can help you to enact a workable plan.

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