How to Get Better at Managing Your Personal Debt (Part 2) Good & Bad Debt
Contributed by @YemiAwop
If you're reading this, I assume you've read the first debt-themed blog post How to Get Better at Managing Your Personal Debt (Part 1) if not, I'd recommend reading that first! In this part, I am going to break down the difference between good and bad debt and leave you with some next steps to enable you to get better at managing your personal debt.
What is good debt?
Good debt sounds ludicrous but it is a real thing. Good debt can be considered as an investment that will grow in value or generate long-term wealth. An example of this would be if the income gained from utilising the loan is greater than the interest paid. That’s why something like student debt could be considered as good since in the long run, the returns you get from having an education would outweigh the cost of taking out a student loan.
Another example would be a mortgage since the hope is that in the long run, the value of the property would appreciate to a level greater than your mortgage repayments. An additional benefit of these types of loans is that the interest is typically low and can be spread over a long time period.
But of course, there are some downsides as there are no guarantees that it will work out as intended. E.g. difficulty in finding a job after graduating, house prices falling, not keeping up with repayments and defaulting.
What about bad debt?
Bad debt can be considered as debt that is used to purchase items that do not increase in value/or provide income, and the cost of the debt will far exceed what the item is worth.
Bad debt typically has a high-interest rate, so the motto is “if you don’t need it, don’t buy it”. The use of high-interest credit cards on disposable items such as clothes, food, holidays can be considered as bad debt if you don’t make the payment in full at the end of each month. As a result, interest will be charged on the portion of the purchase that you haven’t paid off and over time this could grow to a substantial amount. Therefore the total cost of the purchase continues to increase even though the value of the item does not i.e. £150 even though the shoes only cost £100.
I like to call overdrafts the silent killers. You're usually given an interest-free overdraft when opening a student account which comes in handy when times are tough. However, upon graduation, the Bank will begin to notify you that at some point this overdraft will no longer be interest-free.
If you racked up a large balance then it may be hard for you to pay it all back within the allotted timeframe, leading to you being on the receiving end of some hefty fees. These fees can range from £6 to over £120 a month so you want to make sure that you aren't still swimming in that overdraft by then.
Be smart, make sure you check when the interest-free period expires so that you can have a plan in place to clear the overdraft in time.
Whatever your situation and circumstances for having debt, it is essential that you follow the steps below so that you can improve the way in which you manage this debt.
Next steps for improving personal debt
1. Shop around
Don’t always take the first deal that comes to you. Do your research and ensure that the interest rate offered is actually competitive and suits your needs. Make sure that if interest rates were to rise, you’d still be able to afford to pay the loan. If you are already on a high-interest rate credit card, then look for 0% balance transfer cards. These allow you to switch the money you owe to a credit card with a much lower or even zero percent interest rate for a set period of time.
Have a better sense of your expenses so that you know what you typically spend each month. Find which expenses you can easily trim down in order to reduce your unnecessary credit card use.
3. Have a strategy
If you already have debt, have a clear and feasible plan of when you’d like to clear this debt. For credit cards, although they may give you a very high credit limit, ask yourself if you really need that much. If not, then reduce the credit limit to a level that is sustainable.
For overdrafts, to reduce the likelihood of you dipping back into it, begin to cap the overdraft once you hit a clear milestone. E.g. if the limit is £2.5K and you pay down £500, then ask the bank to cap your overdraft at £2K and so on.
Pay the debts which have the most serious consequences first e.g. bailiffs, home repossession etc. Then the ones with the highest interest rates.
4. Speak to someone
Many people may have gone through the situation you are going through. Don’t feel that you have to face crippling debt alone; it is always better to get expert advice on your situation. https://www.moneyadviceservice.org.uk/en/tools/debt-advice-locator.
Don’t let debt weigh you down. Although it can be a dirty word, you have the power to cleanse it, use it and brighten up your future for the better.
If you'd like to book a personalised money guidance session with me, please get in touch with me by using the contact page, giving a brief overview of your difficulties and I'll get in touch with you ASAP. Please note, sessions take place in London, UK.