Not all debt is alike. It can come in many forms from mortgages to student loans, car finance to credit cards. Most people at some point in their lives take out credit, but not all debt is a bad thing.
Why having debt isn’t always bad
If you make payments on time and plan your debt strategically, your debt can work in your favor as it shows you’re responsible when paying it off.
If you have several years of on-time credit card payments, this will help your chances if you come to apply for a mortgage. A credit history is the best way for lenders to tell whether you’re a responsible borrower or not. If you are, you can benefit from lower interest rates.
What is good debt?
Good debt is the kind of debt you take out with careful planning and budgeting. Before taking out any type of finance, consider your budget. Can you comfortably make repayments or will you struggle?
Good debt can allow you to manage your finances more effectively, buy things you need, get you through emergencies, or even increase your net worth.
For example, taking out a mortgage (that you can comfortably afford) is good debt because those payments can:
- Potentially save you money if mortgage repayments are less than rent
- Increase your net worth. Paying down equity on a house means you have an asset that will likely increase in value
Examples of good debt
- A mortgage – This increases your net worth because it’s an asset
- Home equity loans – This type of debt can help you afford home improvements that help you increase the value of your home
- A small business loan – This type of loan is an investment in your career and will hopefully pay off and build your wealth in the long-term
- Student loans – This is an investment in your education that will help you find a higher paying job, build experience, and get the necessary qualifications you need for a brighter financial future
What is bad debt?
Bad debt is when you take out finance that you can’t afford comfortably, that has eye-watering interest rates or leads you into a cycle of debt. For example, a lot of payday loans have sky-high interest rates and are designed to make you reliant on them each month.
Bad debt can also be described as something that loses value once you take ownership. For example, if you take out a loan to purchase a TV, this will instantly lose value.
Examples of bad debt
- Credit cards – While convenient, credit cards are commonly used on unnecessary purchases and can have pretty high-interest rates
- Payday loans – Fast access to cash is handy but the interest rates are often way higher than any other type of debt
How to pay off debt
Paying off debt, whether good or bad debt, is always a smart move. No one wants to be paying expensive interest rates. Paying down debt on time or even ahead of time is also good news for your credit score.
The best way to pay down debt is to come up with a plan and some specific goals.
Use the snowball or avalanche method to clear bad debt first
Start with your bad debt – this is the debt that’s most harmful to your future and finances. Tackle the high-interest debt first, such as payday loans or credit cards and make a solid plan to reduce the amounts.
The snowball and avalanche debt repayment methods are very popular methods. This is where you either start with your smallest debt or highest-interest debt first, prioritize repayments on those, clear them, and then move on to the next.
Calculate how much extra you need to pay
For good debt, it helps to have a plan as well. Set yourself a goal to pay X off by a certain date and calculate how much extra you will need to repay to meet that goal. Commit to those extra payments to clear your debt faster.
Reduce expenses and increase repayments
Another thing you can do is try to reduce expenses in your life to free up money to pay your debt faster. While giving up on buying new clothes or delaying your next vacation may not be quite as fun, you’ll thank yourself later. Once those debts are cleared, you’ll free up a lot more cash to make up for it in the future.
Clearing your debt faster has several benefits beyond saving on interest rates and freeing up cash. There’s an emotional benefit and feeling of satisfaction as well. It can also contribute to building a healthier financial history and boosting your credit score.
If you find yourself in need of a short-term loan today, tomorrow or next month, apply with Jora Credit and we may be able to help you with your current financial predicament.