Good debt vs bad debt - what’s the difference?

Let's learn to differentiate between good debt and bad debt with this article.

What's the key learning?

Debt is an obligation to pay back money that’s been borrowed
‘Good debt’ typically helps you buy something that grows in value, or helps you produce an income
‘Bad debt’ typically is used to buy assets that fall in value, or don’t help you earn any money
Tips on reducing debt!

Ever splurged on a brand new piece of tech and put it on Afterpay? Or what about a HECS loan from the Government to cover your uni fees?

Well, these are both examples of debt.

Sometimes debt is necessary... but other times, it can get you in a bit of trouble.

Let’s break it down.

What is debt?

Put simply, debt is an obligation to pay back money that’s been borrowed from someone else (aka a bank or lender).

People take on debt for a bunch of different reasons, like to buy a house, a car, to pay their uni fees.

Some of this is good debt…and some of it is bad debt.

What is good debt?

Debt can be considered ‘good’ if it helps you earn more money, ie. if it is used to buy something that will grow in value over time, or provide you with another income.

Examples of good debt:

A HECS loan: University degrees can help increase your earning potential.
A business loan: These loans can help businesses expand which will in turn improve your wealth.
A home loan: Property has historically increased in price over time.

And what is bad debt?

Debt can be considered ‘bad’ if it won’t earn you any money, or it is used to buy assets that fall in value.

So, taking out a credit card or personal loan to fund a new wardrobe or a holiday lives in this category, and usually car loans do too (because cars are depreciating assets).

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So should I avoid bad debt?‍

The truth is, bad debts like credit cards don’t have to be bad. If used responsibly, credit cards can help manage cash flow, budget and pay for emergencies without dipping into our savings.

But they also make it very easy to spend above your means. You need to ask yourself if using bad debt like a credit card adds value to your financial wellbeing or worsens it.

How can I get rid of debt?

If you have some debt you want to start paying down, you can:

Write a list of all the debts you owe
Order them in terms of priority (generally it’s best to start with the debts that have the highest interest rate)
Look at your day to day budget and allocate an amount that you can realistically pay off each week
Find a friend or family member to keep you accountable - maybe you can keep them accountable too
Start paying your debt down!

So the next time you decide to borrow money, stop for a second and ask yourself - is this good debt or bad debt I’m getting myself into?

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