Avoiding Bad Debt

I think we can agree that almost everyone has some form of debt. Whether that debt is in the form of a mortgage, a car loan, or credit cards, it can be difficult to exist in our modern society without relying on some form of credit (and, as a result, amassing debt). However, certain types of debt can be harder to manage than other types. These kinds of debt can be difficult to repay and may cause sizable financial stress for you. That is why they are commonly known as “bad debts.”

Bad debt can be exceedingly difficult to resolve, and things can get out of control very quickly. You could even end up in significant financial trouble. That is why it is important to take these types of debts seriously. A good place to start is by understanding the differences between a good debt and a bad debt.

“Good debt” is debt which can improve your financial position. A typical example of a good debt is a student loan. If you borrow money to pay for your post-secondary education, you put yourself in a position to have more job prospects once you graduate and that means you will improve your financial position over time. Mortgages are also often considered to be a form of good debt. Making mortgage payments on time helps you build equity in your home, and once that mortgage is paid off, the value of the home will certainly have increased, based on the real estate market we have seen in Canada over the past 15 years.

However, even student loans and mortgages can be considered forms of bad debt in some situations. If you borrow more than you can comfortably afford to repay, for example, this could turn a good debt into a bad one. It can also be an issue if you complete your schooling but are not able to find a job in your field, or if your home decreases in value (as we have already mentioned, a highly unlikely scenario right now). So, a debt could be considered good or bad depending on the specific circumstances.

That said, many debts are thought to be “bad” in every situation. Credit card debt, especially when the debt is a result of buying luxuries and “wants” rather than “needs” is usually a form of bad debt. This debt will not result in an improvement in your financial situation. When possible, avoid taking on too much of this type of debt. Payday loans are another form of bad debt. With sky-high interest rates charged for this type of short-term loan, payday loans are best avoided.

In our society, most people have some debt. It’s really unavoidable.  It is when we have unnecessary debt or debt that we cannot afford to repay (such as a payday loan) that we could end up damaging our credit rating and our financial situation. That is because these types of debt come at a high cost. You must dedicate a portion of your income each month to paying off your debts and you need to pay interest on the amounts you owe, as well. Depending on the type of debt, these interest costs can be significant.

However, it can sometimes be tough to tell the difference between good and bad debt. That is often because each person’s financial situation is unique.

One key to avoiding bad debt is to avoid spending more than you can afford and not borrowing money without a plan to pay it back. As mentioned, some debts are considered “good” in certain situations but “bad” in others.

A good example of this good or bad debt scenario is an automobile loan. If you need to have a vehicle to get to your job, borrowing money to buy a car could be considered a good debt. That is because owning the car would allow you to get to work and going to work can help you improve your financial situation.

However, that is not to say that you should go out and buy a luxury vehicle if you cannot afford one. Buying an expensive car or taking on a car loan with expensive financing terms, can cause serious financial hardship if you are not able to make the bi-weekly payments, or if you are only able to make those payments by making significant sacrifice elsewhere in your budget. Most of us do not need a high-end vehicle to get back and forth to work, so taking on this type of high-end debt may turn that loan into a form of bad debt.

That is a safe way to think about debt. If a debt is unnecessary or just not affordable, consider whether it makes sense for you to take it on. Before you agree to any debt, honestly think about the purchase. Is it necessary? Do I really need this? Do I have a plan for how to pay off the debt? Is there a more affordable option for me that makes more sense? If you ask yourself these types of questions, if you stick to your budget, and if you do not borrow more than you can comfortably afford to repay over time, you will be in a stronger financial position, and you be assured to avoid bad debt problems.

If you are already coping with some form of bad debt (or even good debt that has become out of control) and do not know how to tackle it on your own, CLICK BELOW FOR A FREE CONSULTATION, or give us a call today. We are experts in dealing with debt pressures and can guide you to a solution where you can turn that bad debt into good debt, and an unpleasant situation into an enjoyable one.