Good and Bad Debt: Understanding the Difference

by Sean Bryant on August 8, 2015

Many of us consider taking out credit for a variety of things – family homes, advanced education, a new family car. But while some of us know the difference between good and bad debt and wouldn’t even consider taking out credit for a bad debt, there will be others who will take out the credit for such a bad debt, such as holidays or the latest gadget or must have fashion item.

Research recently undertaken by the payday loan provider Wonga SA have shown that many people do not know the difference between the two and just how or why taking out bad debts could affect them. Financial literacy is a big issue and something everyone should have – it is important to be educated about financial matters but survey results show that not everyone is as educated as they should be.

Are you able to distinguish between the two? Have you ever taken out credit for something that would be considered a bad debt as you didn’t have the available funds otherwise at the time? The easy way to work out the difference between the two is to work out whether it will give you short term pleasure. If it will only make you happy in the short term and instead you will be left with memories instead of something physical, that should be considered a bad debt. After the original pleasure of the item or trip, there isn’t something physical to show for it which you can say in years time was worth it.

Also Read: Why Failing Isn’t Such a Bad Thing

A good debt is something like a house or university education – something you can look back on in years to come and know that it has given you years of pleasure, whether its from raising your children in your very own family home or getting the career of your dreams thanks to taking your education further.

The important things to consider when thinking about taking out credit is what it is for, whether it is for short term or long term. Can you afford it? Have you got the available funds ready to pay back the credit agreement as and when required? What will it cost you overall? Are the interest rates affordable alongside paying back the original credit agreement. If you cannot find a positive answer for these then the best thing to do is to avoid taking out the debt altogether.

While over 80% would take out good debt for a house and over 50% would for further education, a shocking 5% would borrow for a vacation and 4.5% for things such as the latest gadgets or fashion – with people like the Duchess of Cambridge causing clothing items to sell out as soon as she wears them, fashion is a big money maker and plenty of people wouldn’t think twice about using credit to get the item they want.

Knowing the difference between good and bad debt and becoming totally financially literate is something we should all aspire to, it is important in this credit let world.

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Sean Bryant

Sean Bryant created OneSmartDollar.com in 2011 to help pass along his knowledge of finance and economics to others. After graduating from the University of Iowa with a degree in economics he worked as a construction superintendent before jumping into the world of finance. Sean has worked on the trade desk for a commodities brokerage firm, he was a project manager for an investment research company and was a CDO analyst at a big bank. That being said he brings a good understanding of the finance field to the One Smart Dollar community. When not working Sean and his wife are avid world travelers. He enjoys spending time with his two kids and dog Charlie.

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