What is Good Debt? (Good Debt vs. Bad Debt)

Despite attempts from banks, financial companies, and many charities, the conversation around debt is still very much muted, shirked, and clouded by negative connotations and anxieties. While it’s true that some debt is avoidable and should be avoided, some types of debt can actually be beneficial in our lives and should be treated as such. Read on to discover when and when not debt can be good, what “good debt” looks like, and what the differences between good debt and bad debt are.

What is debt?

Debt is defined as being any sum of money owed from one party to another. It can be small or large, depending on how much is borrowed and varies in type from a small short term loan, to a mortgage, to potentially millions of pounds in business loans. It’s important to remember that most debts will have interest fees that, if unpaid, will accumulate and thus increase the amount of debt owed. The vast majority of debts are taken on in order to finance or fund something that the debtor wouldn’t be able to afford otherwise, such as a university degree or business venture, but they can often be taken out to fund day to day living in difficult times.

Under what circumstances is debt good?

Debt is considered good in any circumstances where it might improve your net worth over a long period of time. These debts allow you to build up your credit score to engage in more expensive purchases in the long run, and when paid off the debtor finds themselves more well off than they were at first. Although these debts might be high value, “good debt” often doesn’t cost the debtor much more than the value of the initial loan, in part thanks to their lower interest rates.

What does “good debt” look like?

“Good debt” often comes in the form of low interest, relatively high-value loans. The value of these loans will dictate roughly how much better off they leave the debtor, so one which leaves the debtor with the foundations of a new business, for example, can be considered a “good debt”. The loan would need to have a low interest rate, as a high-interest loan can leave the debtor in a situation where they can’t afford to pay off their debts. These “good debts” include examples such as student loans, which are managed by the government at a low-interest rate where you may not even need to pay the full sum, and mortgages, which provide a highly valuable tangible asset to the debtor once the debt is paid off. In the case of all “good debts”, once repaid the debtor will find themselves better off than if they had never taken on the debt in the first place.

What does “bad debt” look like?

These debts are often at an incredibly high-interest rate, for smaller sums of money. In these cases, paying back the debt becomes incredibly difficult, as the debtor was struggling with money in the first place and the high-interest rates would just cause the cost of the loan to spiral out of control faster. These loans ultimately damage the credit scores of debtors and just lead to lenders making money, rather than the debtor having an opportunity to increase their net worth through loans. Examples of bad debt include credit card debt that is paid off in a series of very small installments, keeping you “in the red”, and payday loans or overdraft fees, all of these are debts that you may be stuck with for a long period of time as you struggle to pay off any interest or fees.

What are the differences between good debt and bad debt?

“Good debt” is often held through reputable institutions such as big banks or long-standing lenders, through an agreement that secures the rights of the debtor and keeps the costs through interest reasonable and low. This allows good debt to be manageable and ultimately mutually beneficial for everyone involved. On the other hand, “bad debt” often features significant interest rates and long-run costs for the debtor, meaning that they often take a much longer time to pay off and impact the credit score of the debtor in a way that can take years to fix. This means that in the long-term, taking out “bad debt” can force your mortgage to have higher interest rates, and even mean you get denied for certain loans. Whenever you need a loan – be it an emergency short-term loan, or a longer term car loan – make sure that the debt will be beneficial for you in the future, or you could be dealing with the consequences for years to come. Remember – if you are having any issues with debt, speak to one of the UK debt charities listed here.

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