You may have heard that some debts are good and some debts are bad. While it’s not really the debt’s fault if it’s labelled that way, there are some reasons why they may be categorised like this.
“Good” Debt
“Good” debt is debt that will help you make money – such as using the borrowed money to buy an asset that will increase in value over time. This might be a property or shares.
This debt will help you to get in the market quicker and because the purpose of the debt is for investment that often makes you money, the interest might also be tax deductible too (not your personal home loan though).
“Bad” Debt
“Bad” debt is where the debt is used on consumable items that waste away over time. Cars, household furniture, holidays and general living expenses are all things that people might use their credit card for, that if not paid off quickly, will end up costing a lot more in the long run.
What Does This Mean?
When you buy something on a credit card, or with a personal loan, or with interest added, ultimately the cost of that item includes the interest price.
For example – if you buy an awesome holiday for $10,000 and you add it to your credit card to pay off over the next 6 months, you’re also adding the interest to the cost of the holiday. At $2,000 per month to pay off a $10,000 credit card you’re adding an extra $312 in interest (at 18% interest rate). That’s a lot of drinks or even a whole extra night.
If you paid $1,000 per month on the same debt, it would take 11 months and $741 as extra interest.
By smashing down the debt, you save money on interest, meaning that you can use the money for something else. By saving up and paying for the holiday in advance, you’re able to get more bang for your buck, and are able to pay less for the same thing.
The Bottom Line
Bad debt is expensive. The longer you carry it, the more you pay in interest.
Good debt can work for you if you’re using it to buy assets that increase in value or generate income.
Know the difference, and manage your bad debt accordingly.
Disclaimer: This information is general in nature and doesn’t take your personal circumstances into account. Always seek professional advice for your specific situation.
