Not all debt is to be avoided. Here’s how to know if you’re taking on the good kind.
There’s ‘good debt’ and ‘bad debt’. One can speed up your path to financial freedom, while the other can ruin your chances just as quickly.
The easiest way to tell whether you have good or bad debt has nothing to do with the debt itself and everything to do with what you spend it on.
Borrowing money to buy goods and services is generally bad (though there are some exceptions). Using credit cards, Buy-Now-Pay-Later cards or a personal loan to splurge on the latest smartphone, clothes, or a car is a bad idea because these things lose their value. You don’t want to lose even more money by paying interest. If you borrow money to bring forward consumption – so that you don’t have to save – those debts are debt.
Using debt to buy assets, however, can sometimes make a lot of sense. Productive assets tend to grow in value and generate an income for you. The two main productive asset classes are stocks and property, but a third is your education. Borrowing money to get a university degree or to do an apprenticeship is usually fine, but it’s important to consider whether the education program has a strong chance of improving your future income. Getting a loan to do finger painting classes doesn’t count.
Avoid Purchasing Unnecessary Luxury
One of the biggest regrets people can have financially is spending big on things that don’t matter a few years later. A common example is getting on the new-car race. Buying the newest, flashiest car can be alluring to some young people, some of whom go on to trade those cars in for new models every few years. A car is a big purchase with high ongoing expenses and rapid depreciation, from the price of the vehicle itself to insurance, registration, petrol and maintenance.
It’s one item that requires careful thinking and great care when it comes to how you decide to spend your money. Would a second-hand or earlier model car suit your needs just fine? If you’re interested in saving, always aim to tighten the belt when it comes to items you want rather than need.
Always Shop Around
Always look at every deal available before making a purchasing decision, no matter what you’re getting. Many of us are pretty good at doing this when it comes to general shopping such as looking for specials at supermarkets or a department store. It’s easier to get lax about it when it comes to more complicated financial products like home loans or insurance.
Flash advertising, hard-selling tactics and a seemingly unlimited number of products on the market can make the process daunting, encouraging some to just pick something and get it over with. For example, many people just get loans from their bank for the sake of simplicity without shopping around, only to realise later that they are paying some of the highest rates. Getting the assistance of a broker is a great way of avoiding this error.
The Importance of Cash Flow and an Emergency Fund
Some people are very good savers, but then they make the mistake of tying up all their cash in assets such as stocks. This can cause problems if you have to dip into your savings, buy on credit or sell stocks to pay for large savings, undercutting the interest you’re earning and feeling like you’re taking a backwards step.
Be diligent with saving up an emergency fund and ensure you have an adequate level of cash flow for your needs. It’s more advantageous to have a consistent stream of cash along with assets rather than having it all in capital and relying on selling it for a lump sum later.
The information in this article is generic and should not be taken as financial advice. If you need professional financial advice, get in touch with the friendly team at Beyond Loans. We can provide you with a personalised strategy and practical, easy to understand advice about home loans, mortgages and debt consolidation.