As I said in the previous post, not all debt is bad, so we need to understand the distinction between good and bad debt so we know what our debt landscape looks like. Here is the simple distinction:
Good debt is low interest and is used to buy things which appreciate, go up in value.
Bad debt is high-interest and used to buy things which go down in value.
So, a mortgage to buy property is good debt because it’s generally low interest and generally property increases in value over time. Using a credit card to buy a TV is bad debt. Your TV is practically worthless the second you get it out of the box, and the credit card will be attracting double-digit interest until you pay it off. This distinction will help you to differentiate between good and bad debt pretty easily.
Buy Now Pay Later plans, which are the scourge of the high street in my opinion, preying on mostly younger folks who don’t know better, because we don’t teach them to know any better are definitely bad debt.
Most debt to buy a car is bad. Cars always depreciate unless you’re buying a classic Ferrari. There are lots of different options like PCP, HP and Lease Purchase. Unless you can get a zero or very low interest rate on car finance, then generally it is best avoided.
Even insurance policy debt is bad, because you usually end up paying double-digit interest rates to pay your car or house insurance over a year. Even though the pounds and pence numbers might be smallish, it’s still money you don’t have to pay away.
For what it’s worth, I don’t count student loans as bad debt. The interest rate is relatively low and it’s bought you an education which should reap dividends throughout life. Yes, that is a woefully simplistic view! There are different versions of the student loan system which are less favourable, so you may need to take a view for yourself whether you see it as bad debt or not.
Finally, you need to know the distinction between secured and unsecured debt. Secured debt means the debt is linked to a particular asset, usually a house or a car, and that I you fail to make the repayments on the debt, the asset can be taken off you in satisfaction of the debt.
The loan company can take the house off you – a repossession. Or they can take your car if you don’t pay the loans. With unsecured debt that’s not the case, but there are of course still ramifications if you don’t pay. Know the enemy, and know exactly what you’ve got and whether it’s good or bad debt.
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