Good debt vs. bad debt: Is borrowing always a bad idea?

How do you decide if it’s worth getting into debt?

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After some good but many bad choices, in my opinion, any debt is bad.

It might be good if:

  • the item is cheaper on credit (phone contracts are a good example of this)
  • the interest is 0% or the balance can easily be cleared in a low interest period
  • payments could still be made if regular income was disrupted
  • the item can already be afforded but money is elsewhere (e.g a loan for building work while money is in investment / awaiting inheritance)
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I’ve used debt both positively and negatively -

When I look at my debt I always ask myself “what is this debt linked to? What did I get for it”

e.g. I have a £100,000 loan and whenever I look at it i know it is linked to my house - the debt serves a purpose.

I have another loan that is linked to an investment I made and I ask myself “what is this debt linked to, oh yes my shares in xyz”

I also have negative debt, I look at my credit card and see the balance and ask “what on earth did I spend that on?”

Negative debt is also debt that doesn’t seem to shift.

Getting a loan that serves a purpose and has a repayment plan that you know will clear in 24 months is good. Having a credit card balance that never seems to get lower is bad.

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It depends a lot on what you do with it. Eg. I borrowed 13k to buy a car worth 15k, so I have an asset worth more than the amount owing plus the use of that. If push came to shove just sell it and the debt is gone.

My house is worth about what I paid for it but no landlord to cope with so it’s still a good investment.

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Not necessarily. A car isn’t an asset, it’s a liability. It doesn’t earn you money, unless you are a delivery or taxi driver. It also depreciates in the first few years faster than you’re likely to clear the capital and interest. You may find, particularly if it is a newer car, that you owe more than you own. It also attracts other running costs that eat into your disposable income.

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It earns money because it allows me to work. Also unless there’s a crash on second hand prices it’ll always be worth more than the debt, making it an asset. In fact Its value is holding steady right now so it’s not even a depreciating asset

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Does enjoyment come into it? I’ve just ordered a new car. 25% deposit, the rest on finance. I’ll pay interest, the car will depreciate in value to an extent, but I can afford the payments and I’ll gain pleasure from driving it. If I enjoy it and can afford it, should it be bad? Genuinely interested in people’s views.

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If you can afford something, then IMO, it matters not if it’s “good” or “bad”.

Ultimately, a car is a necessity for a lot of people - Are you spending more than you should? Almost certainly… Especially if you are paying for it on finance (unless it’s a Dacia Sandero, which is the cheapest car I can think of right now).

But finance isn’t “black and white”, and I don’t think these articles are about things like car finance, or other “luxury” items…

It’s more to help those who might be a bit stuck with their debt, or don’t know the best way to do things.

Good point, well made. Thank you. Yes, spending on a nicer car than I really need now in my mid 50s, is very different to spending money I couldn’t afford on hi-fi and cameras 35 years ago. I enjoyed those too, but my personal circumstances and financial know-how were very different, and I most definitely should not have bought those things…

The root of the problem is a basic lack of financial education most of us receive at school and at home. The problem isn’t debt. It’s the lack of fundimental concepts that most of us enter the adult world with zero understanding of. If I could go back in time to a 16yr old me I would explain 3 things to myself.

  1. APR - Annual percentage rate. The interest charged on loan over an annual period.

  2. Compound interest - Your arch enemy when in debt. Your best buddy when saving.

  3. Leverage - Borrowing money to finance the purchase of an asset that makes you a profit.

Added to the issue of borrowing money is that many people are unable to understand what an asset is.

A car is not an asset.
A home is not an asset.
A property that earns you an income is an asset.
A business is an asset.
Shares are an asset.

Taking all these things into account the only time I would go into debt for something that is not an asset would be to house my family. Homes are important.

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It would be good to understand why you say a car or a home are not assets?

An asset is something of value you can use to payoff a debt, so by definition these are assets. I’m not sure I fully understand the reasoning behind why these wouldn’t be?

Why does an asset have to make money to be an asset? Surely a car is just a depreciating (rapidly in most cases) asset?

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Cars are an asset. People use “Cars aren’t an asset” as a shorthand way of saying “Cars are quickly deprecating assets that will almost surely lose you capital” which goes against what most assets are.

That’s not to say you shouldn’t buy a car, whilst they’ll lose money in a strict capital sense, you often need it for ancillary reasons like going to work to make money.

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I live by the principle that you only spend what you have.

No student loan or mortgage then?

I didn’t go to Uni and I don’t have a mortgage I rent.

And you intend to buy a house outright with cash or rent for the rest of your life?

Yes, rent.

To be fair I might get a mortgage in the distant future. But when I said " spend money I have " I meant taking out loans from wonga or going into an overdraft etc

I saw what you meant! Some debts, like a mortgage are unavoidable for the vast majority of people.

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For me, a debt has never counted as a debt if the collateral it’s based on is worth more than the value of the debt.

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