You’ve been told that debt is a Bad Thing. You know that it’s better to spend money that you already have than to borrow it and spend years paying it back. You understand that if you were short of money this month, next month will be even worse when you have to start paying the loan back with interest.
And yet, you’ve heard of the notion of good debt. Can debt ever really be good? The short answer is “yes”. The slightly longer answer is “It’s complicated.” Essentially, good debt is defined as debt that improves your life or ultimately benefits you and your financial situation. You must have a sound reason to borrow the money, the capacity to pay it back and the confidence that this is the exception to your otherwise healthy financial habits.
Even those debts that fall under the definition of “good debt” broadly speaking can easily become bad debts if you don’t handle them with care. To illustrate this point, here are some examples of good debt, and how to avoid turning them into bad.
Getting a bond or car financeUnfortunately, saving up the money to buy a home or a car will take you a long time, and chances are you need somewhere to live and a way to get around sooner than that. While the financial commitment of a bond is long and expensive, it serves the purpose of getting you a foothold on the property ladder. Similarly, a car allows you to be mobile and enables your career.
You would probably also incur other expenses if you held out on buying a house or car – including rent or public transport costs – which would minimise your saving potential each month. All of the above reasons push bonds and car finance into the category of good debt, even though they will still cost you interest and fees.
Consider this: As with any debt, you must think carefully about your situation and affordability. Will you move in a few years? Can you really afford to pay for and service the car that you want? Just because these are good debts doesn’t mean you don’t have to make sensible decisions about them.
A business loanIt’s hard to start a business without finance, so you would probably need to take out a loan to set you on the path to entrepreneurship. For instance, if you need to buy a laptop to work from home, or a gas-fitted wagon to run a food stall, these qualify as good debts because they’ll allow you to start earning right away.
Consider this: Do your research and be sure that these costs will increase your prospects in exactly the way that you imagine before you sign on the dotted line.
To study or otherwise improve your professional situationIf a debt will put you in a position to increase your earnings or expand your qualifications, then it’s a good debt.
Consider this: Don’t allow yourself to believe a fantasy. Be sure to do your research so that you know that the debt you’re incurring now will deliver a return on increased earnings or job opportunities when you’ve completed your studies.
A loan that allows you to save moneySome purchases that cost you money now will allow you to save money in future, so it’s OK to borrow for those because you’ll make your money back. For instance, if you were to borrow the money to install a solar geyser, you would realise a return on your investment in a couple of years, and then a reduction in household costs for the future. Likewise, a coffee machine could save you on your twice-daily cappuccino expenses, and a water filter could save you a fortune on bottled water.
Consider this: Always do the maths so that you are sure of what you are getting yourself into, and do the research to be certain you’ll get the returns that you’ve been promised.
Interest-free debtSome lenders offer interest-free debt in specific circumstances – for instance some business accounts allow you to borrow for six months, interest free, and some retailers offer store accounts with a similar deal. Since you aren’t paying any interest for the named period, this really is an advantage for you.
Consider this: Before accepting this kind of deal, be sure that the fees or activation costs for such a loan truly are less than the interest that you would pay, and that you can trust yourself to pay back the total in the time dictated – because when the interest on these kinds of loans kicks in, it’s usually significantly higher than the going rate.
Credit sometimes offers you some perksSometimes, credit providers offer you some pretty good perks to accept their offering. For instance, if you buy airplane tickets on a credit card, you get free travel insurance, and if you take a particular store’s credit card, you may get money back in points at the end of the month.
Consider this: The same two cautions as the previous point apply. You must always look out for hidden costs and be sure you can trust yourself to pay the money back before interest is owing.
The bottom lineThe rule of thumb is simple – you should never buy groceries or food, cover any other monthly expenses, or buy things that you should be saving for with credit. Then, in the rare circumstances where debt will improve your life, and you are confident that you have realistically considered all the possible outcomes, and you can pay it back, then it is safe to call it “good debt”.