Knowing the difference between good and bad debt can help you better manage — and reduce your debt.
When struggling to repay debts — credit card bills, car payments, student loans — it’s hard to think of any debt as particularly good. Think again, as it turns out, that’s not exactly the case. Some debt is better or worse than others, and knowing the difference is important. Bev Moir, senior wealth advisor with ScotiaMcLeod explains how you can distinguish between the two and better assess your financial situation.
For starters, debt is debt; however the distinction between good and bad is based on the purpose for which the debt is taken on. Bad debt is used for the here and now; good debt helps one get ahead financially.
Good debt is like an investment — a home, a piece of land, or even stocks — it is taken on in order to purchase something with value that will increase in the months and years to come.
Credit cards are the most common example of bad debt. Most Canadians have more than one credit card and credit cards typically carry high interest rates, meaning the balance owing can quickly balloon size, and usually has substantially higher carrying costs. If not paid off on the due date, the carrying cost compounds at this high rate and the amount owed just builds and builds.
For potential homeowners, the difference between good and bad debt is important. Carrying high credit card debt can mean trouble for those trying to secure a mortgage. It can reflect poorly on personal credit history and rating. Banks base their decision to lend for major purchases on the borrower’s proven ability to repay; if the evidence isn’t there, lenders may be less likely to approve the desired mortgage.
Tips for Overhauling Spending Habits
- Concentrate on paying off your bad debt first to avoid accruing interest. And to avoid accumulating bad debt in the first place
- Save ahead for purchases that will be enjoyed, and lower the amount of household budget allocated to this type of spending
- Develop a regular savings habit for both consumer purchases and ‘get ahead’ savings