What is debt?

Debt is the amount of money someone owes, that they have borrowed from both formal and informal sources, which they must pay back with interest, as compensation to the lender.

“Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase.”-Wikipedia

Why do people get into debt?

There are many reasons as to why someone would get into debt, one of the biggest reasons being that they cannot afford to buy an item which they wish to own now, because their income/ savings is not large enough to cover its costs therefore, they use a borrowing product to finance its purchase such as taking out a mortgage to finance the purchase of a home. Other reasons could include but are not limited to:

• If an individual doesn’t have a contingency plan or emergency fund in place they may decide to borrow to cover the costs of the emergency expenditure such as, a car breakdown.
• Others may borrow as a way to finance the costs of past borrowing this is not a very sensible strategy as it may lead to the individual incurring a hardcore debt or getting into a spiralling debt problem.
• Others may simply borrow to finance the purchase of consumer items, this trend mainly arose due to the current consumer culture that we’re living in, and the high accessibility of borrowing products.

What is good debt?

Good debt is a debt that an individual is able to afford and repay, something which will result in the individual acquiring something of greater value when compared to the cost of the debt. Some examples of good debt can include:

• A mortgage to purchase a property. This is a good debt because at the end of the repayment term, when you have repaid the sum of the loan you will own the asset, adding to your wealth.
• Student finance/loan. This is also an example of a good debt because you gain skills and knowledge which can put you in a better place in the labour market, and you’ll be more able to get access to higher paying jobs.
• A business loan. This type of loan can be considered a good debt if you’re business succeeds because if successful it can greatly increase your income and the quality of your life.

What is bad debt?

A bad debt is a liability, its something that doesn’t match your affordability criteria and you may struggle to repay it and even if you do repay it, it doesn’t add to the quality of your financial state. Examples of bad debt may include:

• A payday loan to pay for the latest phone or other consumer items.
• Excessive credit card borrowing.
• Hire purchase and other car finance to purchase a new car, this is because they lose value and they also incur extra costs like, MOT, road tax, car insurance and repairs etc. However, if you need a car to get to a place of work or if you’re physically limited and need one than it may not be considered a bad debt. In a similar way a house could also be considered a bad debt or a liability because it results in you having to spend extra money on things like home insurance and renovations etc. however, we do need a place to live and in the long term buying a house is more sensible than renting as the property can rise in value or it could even be rented out, earning you an income.

Factors to keep in mind when applying for/taking out a borrowing product:

1. Any current debts/borrowing products which you may already be using, because you don’t want to be taking out too many loans and find yourself in a situation where you’re unable to repay them.
2. The interest rate that you will be paying on the loan because you don’t want to be spending more on an item than it is actually worth, so look around to find the best rates.
3. The term of the loan, you don’t want to be repaying a loan on eg. a clothing item over 30 years because you will most likely not be keeping a piece of clothing over a 30 year period as it will get worn out. So the term of the loan should correspond to the life of the item the loan is used to purchase.

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