Not All Debt is Bad Debt

"Save for what you want and then pay cash.’ ‘Don’t get into debt: it’s a slippery slope to trouble." Sound familiar? These are among the many myths about credit that many of us grew up with.

Bottom line is, in 2019 precious few of us can afford to pay cash for a home, a car, our tertiary education or even furniture. In fact, having credit is practically essential to navigating modern lifestyles. The trick is to know the difference between good debt and bad debt, and managing your credit wisely.

As rule of thumb, ‘Good debt’ is debt that helps you generate an income, or increase your net worth. Some examples include:

  • Student Loans: Investing in yourself can increase your earning potential – and those increased earnings can help you pay off the debt more easily.
  • Real Estate: There are many opportunities to make money in the property market if you make smart decisions. A simple strategy is buying a home, renovating it and then selling it for a profit – or renting it out on a platform like Airbnb. Commercial real estate is trickier, but can offer good cash flow and significant capital gains.
  • Car Loans: For many, a car is essential – it’s what gets you to work every day, and if you’re self-employed, it’s a key business tool. But be smart about it: buy with your head, not your heart, or it could quickly become a bad debt that breaks your budget.

Bad debt’ can be seen as borrowing money to make vanity purchases that won’t help you generate income. Typical ‘bad debt’ items include:

  • Clothing & Consumables: Buying clothing on credit may seem necessary when you’re overhauling your wardrobe to start a new job, but dressing to impress can have a downside. Clothing doesn’t increase in value and the interest repayments can leave your finances looking threadbare. Paying for a holiday, restaurants and entertainment with credit also has no material benefit – all the interest you’re paying could be used to pay for other, more necessary things.
  • Credit Cards: This is a convenient form of credit but is often accompanied by eye-watering interest rates. Credit card debt is one of the quickest entry point to a bad debt spiral if you don’t manage your payments properly. If you’re having trouble making ends meet, reassess your finances and try to budget smarter, rather than incurring debt that only increases exponentially with interest repayments.
  • Micro Loans: A lot of people fall into the trap of taking out micro loans to get them through the month or pay unexpected expenses. These loans have extremely high interest rates, and should be avoided wherever possible.

Regardless of the type of debt, it’s important to manage it properly – being smart with your money isn’t about avoiding credit altogether. Good credit health is about meeting your obligations timeously to maintain a positive credit report. Any failure to keep up with your credit obligations can have a negative reflection on your credit report, which can have a longer-term impact down the line when it comes to securing credit in future.

One of the first steps on the path to good credit health is to review your TransUnion Credit Report and see where you’re performing well – and where you could be performing better. Most importantly – keep up with your repayments and consult an expert if you’re having trouble budgeting correctly.

Being smart with your money will reduce your debt – and if you absolutely have to apply for credit for something, make sure it’s something that’s going to improve your net worth and not a luxury that’s only going to cost you in the long run.