Good Debt vs Bad Debt: Understanding the Difference
Debt is often viewed negatively, but not all debt is created equal. As a financial advisor, I frequently help clients distinguish between good debt and bad debt to ensure they make informed borrowing decisions. Understanding the difference can be crucial to achieving financial stability and long-term wealth.
What is Good Debt?
Good debt is borrowing that can potentially increase your wealth or improve your financial position over time. This type of debt typically comes with lower interest rates and is used to fund assets that appreciate in value or generate income.
Examples include:
Mortgages: A home loan allows you to purchase a property, which often appreciates in value over time.
Student loans: Investing in education can lead to better career opportunities and higher lifetime earnings.
Business loans: Borrowing to expand a business can generate higher profits and create financial independence.
Investing in property: Buy-to-let mortgages can provide rental income and long-term capital appreciation.
When managed wisely, good debt can be a powerful tool for building wealth.
What is Bad Debt?
Bad debt, on the other hand, is borrowing that does not contribute to long-term financial growth and often carries high interest rates. This type of debt is typically used to fund depreciating assets or unnecessary expenses.
Common examples include:
Credit Card Debt: High-interest debt used for everyday spending can quickly spiral out of control if not repaid in full each month.
Payday Loans: Extremely high interest rates make these loans difficult to repay, often leading to financial difficulties.
Car Loans (for non-essential vehicles): A brand-new car loses value rapidly, meaning the loan is often worth more than the asset itself.
Retail Finance & Buy Now, Pay Later (BNPL) Schemes: These can lead to unnecessary spending and high-interest charges if payments are missed.
How to Manage Debt Wisely
Prioritise paying off high-interest debt first.
Ensure good debt is manageable and contributes to long-term goals.
Avoid taking on bad debt for non-essential purchases.
Seek professional advice before making significant borrowing decisions.
Debt, when used correctly, can be a valuable financial tool. By distinguishing between good and bad debt, you can make smarter borrowing decisions that support your long-term financial success. If you're unsure about your debt strategy, consulting Universal Finance can help you stay on track and build a secure future.
