At Bayport we believe in borrowing for the right reasons because there is a huge difference between good and bad debt and what they can do to your long-term financial wellness.
One of the great truths of financial wellness is that what do you with your money is far more important than how much you earn.
The same applies to debt: why you borrow is more important than how much you can afford to repay.
The reason for both these statements is that faulty financial thinking and poor money habits will land you in trouble, regardless of the amounts involved. The mistakes you make with small amounts of money will become bigger with bigger amounts. And if you borrow for the wrong reasons (even if you can afford the repayment), chances are very good that you will borrow yourself into trouble in future.
What is the difference between good and bad debt?
A loan is not good or bad in itself. It is your reason for borrowing that makes the difference. Good debt is when you borrow money so that you can improve your financial situation in future.
Examples are loans for:
- Education, to give your children (and you too) a better chance at building a successful future.
- Starting or improving a small business, to build a new or additional income stream.
- Buying, building or improving your house. You get a home to live in and, if you choose well, an asset that will increase in value. If you use the loan to buy a second property, you can rent it out and improve your income.
- Debt consolidation, to immediately improve you cash flow while you work towards
becoming debt free.
- You can see from these examples that the right debt at the right time can be a powerful tool to help you build a financially healthy future.
Now let’s look at bad debt.
Bad debt is loans that only satisfy an immediate need, such as groceries until the end of the month, or loans for things that don’t increase in value over time, such as cars, designer clothes and accessories, and furniture.
Examples of bad debt are:
- Payday loans. They are very expensive and often get you trapped in a debt cycle.
- Lifestyle loans. If you are borrowing money for weddings, birthday parties and even funerals,
or to go on holiday or pay for a new outfit, you are borrowing for the wrong reasons.
- Car loans. This can be a grey area because we all need transport. However, when you take out a loan to buy a flashy car when you could have paid cash for a second-hand one, then you know that you’re in bad-debt territory.
Is it possible to avoid bad debt?
We are living in tough times with prices going up and many salaries staying the same.
Despite this, you can stay away from bad debt by asking yourself three questions before signing a loan contract.
- Why do I need it? Make sure that you are taking on debt because you need it and not just to buy things you want. But even if the loan is needed, take some time to ask yourself a few further questions:a. Why don’t I have savings or an emergency fund to cover this expense?
b. Do I know where every cent of my money goes every month?
c. What does my expense tracking tell me about how I spend my money and how I can improve it?
d. Am I budgeting properly and sticking to my budget?
e. What can I do differently to avoid borrowing for the wrong reasons in future.
- Can I afford the loan? Make sure you understand the full cost of the loan and that you know exactly how much the monthly payment will be. Work the repayment into your budget to make sure that you can keep up with the payments.
- Does the loan fit in with my long-term goals? The debts that you take now should help bring you closer to your long-term financial goals. If it is doing the opposite and keeping you away from your goals, then you need to think again about taking out the loan. Credit is a powerful tool to help you achieve your goals in life, but only when you borrow for the right reasons. If you are unsure, speak to a money-savvy friend or a Bayport consultant about the loan you are considering.