Good vs. bad debt

Understand the difference between debt that can help your future and debt that may cost you more than it’s worth.

Transcript

There are different types of debt. Some debt will help you build security, while other debt will drain your finances and leave you with minimal long-term benefits. Debt is also more common than many people think. Things like mobile phone contracts, mortgages and schemes such as Forces Help to Buy are all forms of borrowing.

Some people believe that no debt is good debt, but in reality, avoiding debt isn’t always possible. Sometimes, credit is needed to secure yourself a better financial future.

For example, borrowing money may be the only option when you are buying your first home. This is called a mortgage. If you decide to go to university or higher education, you may have to take out a loan. You might also want to start your own business, which again could require borrowing.

These decisions to borrow are based on your belief that they are an investment in your future. But as they are large sums of money, always check that you can afford the repayments before you borrow. And make sure you know exactly what the repayments will be.

For small items like clothes or a piece of furniture, ask yourself if you really need it. They’re very likely to drastically drop in value, so you could end up paying more than the item is worth, or still be paying it off long after it’s no longer usable.

It’s also worth knowing that borrowing sensibly can sometimes help you later. Lenders sometimes look for evidence that you can manage credit reliably. If you’ve never used credit at all, they have less information to judge your ability to repay, which can make things like mortgages harder to access. So the goal isn’t to avoid all debt, but to use it wisely and in line with your longer-term goals.

For more on what lenders look at when deciding whether to lend to you, check out our video on credit scores.

When deciding to take on debt, ask yourself: is this an investment in your future or is it meeting an essential need? If it’s not, it may be worth rethinking. Will your future self thank you for taking on this debt, or will you regret it?