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Good Debts vs Bad Debts

Updated on February 5, 2012

Not all debt is bad and not all debt is good. I think the one thing I’ve learnt from being in debt is that we had bad debt. It all boils down to managing your money and being smart about it, this is what differentiates the two.

When I was in debt it was bad debt. My ex and I were living beyond our means, doing and buying things we couldn’t afford. Things we didn’t need to keep up with the ‘Jones’s’, that’s what it really was all about. If I’m honest with myself it was just so that we could keep up with so and so. It was crazy. If you can’t afford to buy something cash that you don’t need and you do, that’s bad debt

Looking at bad debt

Buying something that goes down in value immediately is bad debt – says David Bach author of The Finish rich work book. Bad debt is when we buy disposable items using high interest credit cards. When you take out a credit card and you are unable to pay the full amount back immediately you get high interest charges. My ex and I bought a car on our credit card. The minute we dove off that car depreciated in value and our credit card increased in interest. We were loosing money fast. We had a nice car and yet our savings account was bare. Thinking about it now makes me realise how daft that was but I’m glad that I woke up to this and I’ve changed my spending habits.

What about your clothes. Did you buy them with a store card? The clothes loose value the minute you buy them and this is bad debt. Store cards give us the impression that we can save. I remember visiting a shop once, when I was about to purchase a dress the store assistant offered me a store card in exchange for 20% off the purchase. What I already knew at the time after years of bad debt was, that even though the deal looked tempting over the long term it didn’t make financial sense. I may have saved by getting 20% off the dress but the interest I would pay on the store card would outweigh the saving and thus making me worse off and not better off. So there really wasn’t any saving was there? We get trapped into believing we can save by taking a purchase on a store card. Even if you tell yourself you’ll pay it up immediately, if that was the case then why not pay cash there and then.

Looking at good debt

Good debt is an investment that brings you value. Your mortgage for example is good debt. It is better to own your home than to pay rent and at the end of it get nothing out of it. Even with the drop in house prices, it’s still better to own your home than to pay rent. Over long term that mortgage will clear and you will own your home, to me that is a great investment and good debt. A student loan can be viewed as good debt, you are investing in education. At the end of it you’ll be qualified as something. That’s debt put to good use. Once you have your high qualification you find that good job that will help pay off your student loan. Borrowing to invest in a business that will bring you a return is good debt. You are using that money to generate more money and that can be viewed as good debt.

I’ve often wondered if it was better to pay off debt first before having any savings. I had to think hard about this because I realised that my debts were eating away at my wealth. Just looking at the interest from both ends made me think that it was better to pay off debt first. Yes I believe you should have emergency money and that’s a personal choice but after I did the maths, I chose to clear debt first before saving. It made more sense to me as debt was stealing my wealth. This is what made me make this decision.

Credit card debts APR 29%

Interest on Savings 3%

It doesn’t take a genius to figure that one out. It felt like putting water into a bucket with holes in it. It honestly did.

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