WTF Is Bad Debt?
Before you start investing your money, get a handle on your personal finances by cleaning up your “bad debt” – this will leave more money to save and invest.
WTF Is Bad Debt?
Debt, although not strictly black and white, can roughly be split into two categories: good debt and bad debt.
Good debt is borrowing to invest in something that increases in value or provides an income (like a house or a university degree), as long as you can comfortably keep up with the payments.
Bad debt is borrowing to buy something with no lasting value, that doesn’t provide an income, and that you’re paying high interest rates for – like a fancy suit purchased with a credit card (or even worse, a payday loan). Both good and bad debt carry risks, but bad debt is just a drain on your finances that doesn’t offer any prospect of paying for itself (like a university degree might).
Why Should I Care?
Since bad debt isn’t providing an income or increasing your wealth, you’ll be paying through the nose without much to show for it. But good debt can be risky too: investing in something doesn’t necessarily mean the investment will pay off (e.g. if you get a big mortgage but your house price falls, you are still on the hook to pay back the original loan based on the price you bought it at).
Affordability is an important consideration in both cases. Any sudden financial shocks (like an expensive medical emergency or a divorce) can push you into “debt traps”: where you miss payments and are charged additional interest at higher rates and consequently need to keep borrowing more money to pay off your increasing payments. This becomes a vicious circle.
What Can I Do?
- Prioritize paying off any high-interest bad debt you currently have as soon as you can, like credit cards and payday loans.
- Don’t borrow to invest in anything with unpredictable value (like bitcoin), depreciating value (like diamonds), or to buy something you don’t need (like a 4th pair of shoes).
- Don’t borrow money to pay off a loan if you have any other option (ask friends and family for help, rent out a spare room, work extra shifts, etc.).