At some stage in our lives, a majority of us will go to a financial institution to borrow money. A first car, first home, going to college, setting up a business, a wedding day, there are so many reasons we may borrow. Getting approved can be such great feeling. However, after a few months, some people may have more than one loan and might forget how long a particular loan is for or even the rate of interest being charged. For others, getting a loan might raise affordability questions or because they haven’t managed credit well in the past could mean they face difficulty getting loan approval in the future for more important needs.
Credit and debt has been in use for a long time. There is no absolute reason why we shouldn’t use credit and having some debt can help to support life events such as buying your first home, but how we use credit matters for our overall long term financial wellbeing. In this context, we examine the issue from a ‘Healthy debt’ and ‘Bad debt’ perspective.
So let’s have a look at what ‘healthy debt’ and ‘bad debt’ really means, situations where they apply and how to be smart when it comes to using credit.
In general, healthy debt is when you borrow money to improve your life and when you can comfortably manage this debt. It might be to buy a car in order to get a job, for example. So, while the value of the car will decrease in value over time, securing the job has many positive benefits, not least the impact on household income and personal financial wellbeing. Healthy debt also includes such events as the purchase of a home and funding of an education as long as you can comfortably manage the debt.
To keep the concept of ‘healthy debt’ in perspective, it should generally be for supporting personal life events that you value. Another test for vetting the purpose of such debt would be to consider whether or not in 6 months’ time, you can still say with confidence that the debt has had a positive life impact. If you can, its healthy debt, if you can’t, it isn’t!
Bad debts are those that drain your wealth, are expensive and unaffordable. Normally, this debt would not be described as supporting any long term value. Or at a minimum; it has not been used for a personal life event. Bad debts are likely to have unrealistic repayment plans and often run when people make impulse purchases of items they don’t really need or borrow money to pay everyday bills. For example, borrowing excessively for an expensive holiday or top of the range car, offers you only fleeting value while coming at a significant long-term cost.
Credit cards and personal loans can be convenient to access and monthly repayments may seem reasonable. However, as with all forms of credit and debt, interest adds up over time. Buying those new clothes from your favourite brand or that lavish night out at the fancy restaurant, while they may offer a short-lived feeling of euphoria, come with long-term financial costs that needs to be repaid. And when it comes to repaying credit card debt, it is unlikely the night at that lavish restaurant will be remembered by the time the credit card bill is repaid in full. If you haven’t got the money to begin with, sit back, pause and think before you spend.
When borrowing and debt is used wisely, it can really support your future financial wellbeing. So evaluate your options before you borrow. Ask yourself if a debt will make your life better over the long-term. Consider how debt aligns with your short term and longer-term money goals are. If debt can serve as a positive force in your longer-term financial wellbeing, then it is most likely healthy debt. If it won’t, it is most likely bad debt and you should think hard before taking it on.
Take a Financial Wellbeing HealthcheckThe information prepared above by Bank of Ireland “BOI” is for information purposes only and does not constitute financial or tax advice. You should seek assistance from a professional if you require financial or tax advice. No liability is accepted by BOI for any errors or for any loss to any person in reliance on this information. BOI believes any information to be correct at 19 October 2021, the time of publishing and the information is subject to change without notice. BOI does not make any representations or warranties in respect of the accuracy of this information and is not responsible for the content of external sites. Please refer to our Term & Conditions for the use of the Bank of Ireland Group Website for further details.
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