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Walking the line between good and bad debt

Debt might not be a major issue for you right now, but it’s still important to know how to balance good and bad debt…

When it comes to any future purchases or commitments, have you ever thought about what’s worth going into debt for, and debt that’s best avoided?

The trick is knowing how to balance the good and the bad. Allow us to talk you through the options…

When it might be worth going into debt for…

Some debt is considered an investment – this is good debt. You might borrow money to pay for something that could increase in value or add to your long-term financial well-being, such as mortgages, student loans or investing in your own business.

Good debt has been well-researched: you know you’re getting the most appropriate interest rate, term of contract, amount, and the way of borrowing.

Debt best avoided

Other borrowing should be avoided. If you borrow money to go on a luxury holiday, for example, you may come back feeling refreshed but that holiday won’t increase in value. Plus, if you pay for that holiday by credit card, you could incur additional fees, as well as the cost of using your card abroad.

Avoid using credit to pay for everyday items such as groceries or the gas bill, and be realistic about what you can afford.

While no one is suggesting you go through life never buying non-essential items, it’s important to remember the repercussions of being in bad debt. When faced with a purchasing decision you are not 100% sure about, there are a few questions you can ask yourself.

  • If I borrow this money will I be better off in the future?
  • Do I understand the debt and am I confident I’m getting the best deal?
  • Is this the cheapest way to borrow the money I need?
  • Will it be a stretch to make the monthly repayments?
  • Could I still afford the payments if the interest rates go up?
  • Have I read and understood the T&Cs?
  • Do I understand the consequences if I miss any repayments?

Make time to reflect on your spending and think about how you can change some of your more questionable buying habits. Think before you spend – and never spend beyond your means.

When good debt goes bad

There’s an element of risk with all debt, and even good debt can go bad. Here’s how to tell if good debt isn’t as good as you think it is.

  • The interest rate is variable or higher than average
  • You’re missing out on mortgage or loan tax breaks (while personal loans are not tax deductible, the interest on mortgages, student loans and business loans can sometimes be deducted on your yearly taxes – meaning you have less taxable income – check the HM Revenue & Customs website* for more information) 
  • A secured debt (one that is tied to an asset) is putting those assets at risk. You never fully own an asset that is tied to a debt until the loan is completely paid off
  • You will still be in debt once you’ve retired 
  • More than 36% of your monthly income goes towards debt repayments1

It’s virtually impossible for most of us to live debt free, however, it is possible to borrow money the right way. You just need to do your homework. Don’t be scared of debt, instead use it improve your life and invest in your future. And remember: too much debt – good or bad – should always be avoided.

We’ve based the information in this article on our understanding of HM Revenue & Customs practice as at November 2016. Tax rules are subject to change in the future and depend on your individual circumstances.

*We are not responsible for the content of other websites.

1 http://www.bankrate.com/calculators/mortgages/ratio-debt-calculator.aspx

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