Debt can be inclusive of a number of different types of financial borrowing, such as a credit card, a mortgage, a personal loan, payday loan and car finance amongst many others. As cost of living continues to increase, at a rate of around 2.4% a year between 2006 and 2018, some individuals may require some form of financial aid, particularly in the event of an emergency. At the end of January, UK adults owed £1.680 billion, an increase of £48.7 billion from January 2019. That’s an extra £923 per UK adult over the year, with the average household debt, including mortgages, at £60,363.Of these totals, how much is perceived as ‘Good’ debt and how much is ‘Bad’ debt, and is there actually a difference? As responsible lenders here at Wizzcash, we’re taking a look at what constitutes as good and bad debt and why the terminology can send the wrong message to consumers.
What is Good Debt?
There are many components of what makes a debt ‘good’, but it generally still refers to borrowing money that then needs to be repaid. According to the Money Advice Service, a good debt is one that is a sensible investment in your financial future. It should leave you better off in the long-term and should not have a negative impact on your overall financial position. The borrower will have a clear and specific reason for taking on the debt and a realistic plan for repaying it, to clear the debt outstanding as quickly as possible in one lump sum or a series of affordable repayments.
Many will identify this with the most common debts someone can take out like a mortgage when buying a property, or an affordable personal loan or short-term loan. A ‘good’ debt is one that is well considered and only taken on if it is affordable to repay without causing financial difficulty. Other types of ‘good debt’ can include a student loan when needing financial support to pay for university or investing to develop your own business, as long as the business plan is sensible and realistic.
What is Bad Debt?
At the end of 2019, a survey from Money.co.uk found that 63% of UK adults between 16-64 years old were entering the new year with some form of personal debt, with 33% having between £2,000 and £10,000 to pay back. Further details found that 19% had this debt due to holidays, 18% towards paying for Christmas and another 18% attributed buying luxury items. When we start to talk about ‘bad’ debt, it generally refers to taking on borrowing to pay for non-essential items and expenses, such as holidays, gifts and luxury items. It also covers any debts taken on that people can’t afford to pay back or those that will provide little return in future, such as poor investments. Impulse buys on credit or any borrowing taken out to cover everyday bills are considered ‘bad’ debts. This can indicate difficulties to other potential lenders and therefore may result in fewer choices or options being available for credit in the future.
During 2019, Citizens Advice dealt with 2,616 new debt problems every day in the year with 336 people declared bankrupt or insolvent each day. ‘Bad’ debt overall is where better choices could have been made and, in some circumstances, can be avoided altogether. If the debt is for something non-essential and is not affordable, more often than not it is ‘bad’.
In simple terms there are no differences between the types of debt, it is more in relation to how people justify taking on further borrowing. Different perceptions of why someone decides to make a purchase or take out a loan or credit card differs between people. When talking about good and bad debt, what is meant is making a decision based on necessity as opposed to a luxury.
The confusion can lie in thinking ‘good’ debt comes with fewer consequences than ‘bad’ debt. The reality is, no matter the type of debt being taken on if someone suddenly suffers a loss of income due to unemployment or redundancy, a perceived ‘good’ debt, like a mortgage, will still need to be paid despite changes in circumstances. Good debt can easily become bad debt if your circumstances change. Last year, a survey by SalaryFinance.com of 2,000 UK adults found that 75% of people considered a mortgage as a ‘good’ debt and 47% said the same about student loans. When it comes to overdrafts, 61% said using one constituted bad borrowing, whilst 18% said it is ‘good’ debt.
According to the Bank of England (BoE), debt isn’t necessarily bad, but it can be if events like the financial crash in 2008 happen. The BoE keeps the financial system stable by making sure people’s debt doesn’t pose a risk to the wider economy if a worst-case scenario occurs. This stops risky mortgages being sold to customers, meaning better choices are widely available. The other thing to consider is that both perceived ‘good’ and ‘bad’ debts may influence someone’s credit file. If, for example, they apply for too many lending products in a short space of time, even if they are perceived ‘good’ debts, it may still have a negative impact, the same if payments are regularly missed. According to Equifax, taking out a loan or credit agreement without first ensuring you can pay it off, can result in missing or late repayments that will be noted on your credit report and might be considered ‘bad debt’.
Making Better Decisions
At Wizzcash, we are firm believers that before taking out any form of borrowing, people should review their financial circumstances. Checking exactly what you can afford to pay will help to make better decisions. You may discover that your disposable income is much lower than anticipated, meaning any further borrowing would be difficult to repay. To make ‘good’ debt decisions you need to have good affordability.
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