Understanding the Balance: Do You Know Your ‘Good’ vs ‘Bad’ Debt?

Almost every adult will, at some point, require credit financing for one reason or another. Some of the most common debts include mortgages to purchase a home, vehicle financing, personal loans, and credit cards used to pay for online expenses.

However, some debt, in the right circumstances (more detail on this can be found here – scroll to the section titled ‘Quick loans and your credit score’ for a detailed explanation) can help improve your credit score and enhance your financial position as perceived by potential future lenders, to improve your odds of ensuring access to safe, secured borrowing to get onto the property ladder or fund a place on an educational course.

Bad debt, in contrast, can have terrifying long-term ramifications. Causing a spiralling situation with un-payable amounts falling due, where taking out more borrowing to keep up with repayments is a challenging, if not impossible, situation to recover from.

What Is Good Debt?

In essence, good debt is borrowing from a regulated, respected lender with an affordability assessment and other consumer protections applied to ensure you are not offered debt with unreasonably high-interest rates.

Good debts provide a tool for responsible financial management and assist individuals and families in improving their lifestyle while remaining manageable alongside their other outgoings.

Examples of Good Debt

• Borrowing to purchase a property.
• Financing a university place or other education.
• Purchasing a vehicle to be able to apply for jobs.

These debts should always be repaid on time, usually split into monthly repayments over the term of the loan. Provided you make your repayments, the record of positive borrowing will reflect well on your credit score and mean that, in the future, you will likely be eligible for more competitive interest rates and have a wider choice of lenders to choose between.

What Is Bad Debt?

Any debt which puts your finances under unnecessary pressure and is difficult to ever pay back in full or carries increasing charges and compound interest penalties is considered a bad debt.

Most bad debts are very short-term, have little security, and, even when compliant with regulatory restrictions, can levy high-interest charges, which mount up rapidly if you cannot settle the balance when it falls due.

Examples of Bad Debt

• Payday loans and other short-term borrowing.
• Personal loans used to repay other debts.
• Credit and store cards.

Debt that indicates that a consumer is using borrowing to finance their everyday outgoings is often a red flag for lenders and underwriters because it demonstrates a position where the borrower seems unlikely to return to a positive cash flow – their income will continue to be less than their debts.

Once a debt becomes late, problems like defaults and court orders are recorded in your credit file and worsen the situation by making it harder to apply for other debt from regulated lenders, which you can use to consolidate another borrowing and repay gradually at a viable interest rate.

While debt can be useful and is widely available for a range of purposes, it is essential you avoid bad debt and have a full understanding of your financial responsibilities before accepting any lending offer. If you’re struggling with debt reach out to your local debt relief resources.