Have you heard of a friend or family member boasting about the amount of debt that they have? You probably think that they’ve lost it and immediately lecture them on the dangers of debt. After all, it’s the first thing that pops up in most of our minds.
Debt has received a lot of negative attention – and for good reasons. I’d also lecture my family member or friend about taking on debt but remember that not all types of debt are the same – and good debt does exist.
Knowing the difference is crucial for wealth creation. So, with most of us bound to get into debt at one point or another in our life, knowing if it’s good or bad is important.
Good debt boosts your future earnings ability. When using debt to purchase a productive asset or increase your earnings capabilities, the debt is considered good – for example, student loans, home loan or small business loan.
These types of debt are more long-term and can also be tax-deductible (reducing the taxable income amount by the interest costs). However, the need to remain disciplined and not take out too much debt does still apply. Fast-tracking the re-payment of these types of debt can make good debt, great debt.
Using debt to buy clothes, furniture, accessories, pay for weddings or parties, no matter how nice they make us feel, are common examples of bad debt. I’m sighing too. But rather than using bad debt, include an amount for spending on these items in your monthly spending plan. Or, save up money to spend on these items – it’s also harder to spend saved money because of the discipline required to start and continue saving.
When buying these items, you’re preventing yourself from saving and investing. If bad debt was already bad, it actually gets worse. Not only do you end up with an item which depreciates every day, but the interest rates applied to these kinds of debt are extremely high too.
Buying a car on credit is also not the best form of debt. The moment you drive it out of the showroom, it’s value drops very quickly. While walking 12km to work in the morning is not really a viable option, a car should be bought strategically. Second-hand cars offer more bang for your buck – especially those with the balance of their service plans remaining. Also, remember that you still have to pay for ongoing maintenance costs like insurance, tyres, services and fuel.
I’ve got debt – what now?
You need to pay off your bad debts first before you can even start thinking about saving and investing. Devise a spending plan and use 22seven’s free budgeting tools in order to help you find those unnecessary expenses and fast track the repayment of bad debt. Then, work towards paying off your good debt too, while reaping the benefits of that good debt and saving or investing in your future.