Debt is almost always portrayed in a negative light.
We talk about 'falling into debt', a 'debt spiral' and being 'saddled with debt'. Sometimes borrowing money can be financially crippling, but other times going into debt isn't such a bad idea - in fact it can be a very useful tool for increasing wealth and enhancing your life in a long-lasting and meaningful way.
Key takeaways:
Sometimes it does take money to make money. While it would be great if nobody ever had to borrow, it would be unrealistic for the vast majority of people - especially when we're talking about purchasing big items like a home.
If taking on a debt can significantly improve you and your family's wealth and quality of life, debt can be very beneficial.
Some examples of good investments include:
Education. There is a direct correlation between quality of life and education. Higher levels of education are correlated with a better health status, lower unemployment, more social connections and greater engagement in civic and political life. Higher education can increase job prospects, so borrowing a loan from the government to go to university, take a teacher training course or get a diploma might be a wise idea for your future.
Buying a home. Most people have to take out a loan to buy a house. Although prices rise and fall, homes have consistently been good investments in the long term. Pride of ownership is another reason people enjoy owning their homes. It means you can decorate the space to fit your tastes and truly call the house your own, while also bringing a sense of stability and security to you and your family.
Starting a business. Borrowing money to start your own business can be both financially and mentally rewarding. It means that you can do what you love, work on your own terms and sign your own paychecks. Though it does come with its own risks - fewer than half of UK startups survive beyond 5 years and 60% of new businesses go under within 3 years. If you need that leg up to get a business going, make sure to consider all the risks involved and have a solid plan in place.
The general rule of thumb is that you shouldn't borrow money to pay for anything that won't go up in value or generate income (known as a 'depreciating asset').
Depreciating assets include:
Cars. Lots of people consider borrowing money to pay for big-ticket items like a car. However, right from the minute you're handed the keys the car begins to lose its value. That means that from a financial perspective you're already losing out, before even taking into account interest on the loan. Cars and petrol can be very expensive so ask yourself whether you really need a car - consider using public transport or cycling. If you really need a car but cannot afford one, you should look for loans with little to no interest.
Clothes. There has been a huge surge in recent years of customers taking on debt to purchase clothes, especially with Buy Now Pay Later schemes such as Klarna and ClearPay. 44% of people were even unsure whether BNPL schemes meant taking on debt or deferring a payment. Clothes quickly lose their value, and you even stop valuing them as highly when they're no longer shiny and new (a concept known as hedonic adaptation which you can learn more about here)
Luxuries. This might include things like a holiday or a 70" TV. While they'd be nice to have, they will not bring value or generate income, and you'll end up paying more with the interest rates on borrowed money. The trick is to make a budget and put by any leftover money towards savings. Once you've saved up enough, you'll be able to enjoy spending money on luxuries without the burden of debt hanging over you.
The lines between good and bad debt are not always clearcut. Taking on debt may not be as risky for a very wealthy individual who can afford to lose the money if things go pear-shaped, compared to an individual with less money.
Depending on your financial situation, the amount of money in the bank, and many other factors at play, some types of debt may work for some people and not for others. One such example is debt consolidation loans.
Borrowing a debt consolidation loan to pay off debt. This can be a slippery route to go down and is definitely not recommended for everybody. Borrowing more money to pay off borrowed money should never be your first option - you should do everything you can to stay on top of bills, make a realistic budget and prioritise your spending.
Debt consolidation loans can help some people to pay down their debt faster and make debt easier to manage. It involves taking out a personal loan and using it to pay off all your debts at once. The new single monthly payment is usually lower than the previous sum of monthly payments, and the interest rate is potentially more forgiving. Plus, if you make a repayment on time every month you will be able to improve your credit score.
That said, debt consolidation loans are not without their drawbacks. There can be expensive set-up fees, things such as your house or car can be repossessed if you fail to pay on time and missed payments can damage your credit score.
Think very carefully before taking on debt, and don't be afraid to seek free, independent debt advice from the likes of StepChange or Citizens Advice.
