How to differentiate between good and bad debt

Being indebted is not necessarily a bad thing, provided you know the difference between good and bad debts.

08:27 08 October 2013

Most people would like to live a debt-free life, but that is rarely possible, especially with the current economy situation in the UK. However, there are many ways that you can go about your debts in order to end up with a good credit balance. One way to get to grips with the situation of your debt level is to know the difference between good and bad debt. Let’s examine this:

Your debt is good if:

• You use the debt to purchase an item that will increase its value in time. In this way, even if the interest rate is high, you will earn more money than you initially invested;

 

• The interest rate is very low or close to zero. Even though you have a debt, at least you know that you will only pay back what you borrowed and nothing else on top of that;

 

• It has a rather long-term repayment deadline. It is possible that in this case the inflation will reduce the value of your debt by the time you have to repay it;

Your debt is bad if:

• You use the debt to pay for items that diminish in value over the time. It's true that there is no certainty as to what the value of an item will be in the future, but you should try to trim down the risks as much as possible;

 

• The interest rate is very high. You end up repaying the debt numerous times over, so always be on the lookout for low interest rates if possible;

 

• It has hidden commissions. You should always read the documentation of your debt closely before signing it up;

These are some of the key factors that decide whether a debt is good or bad. Remember that while being indebted is a bad thing in itself, there are ways to reduce the financial damage yet.