Bad Debt and Consolidation
It may seem nonsensical to describe some debts as ‘good’ and some as ‘bad’, but the difference between the two is also key to managing your personal finances effectively.
Many types of debt that we get into are to fund purchases of one kind or another. If you’re getting a loan to fund something that will increase in value over time, this is a debt that will theoretically put you in a better financial position in the long run. The obvious example of this kind of ‘good’ debt is a mortgage, as a home will typically appreciate in value over the time that you own it.
On the other hand, most of us also find ourselves using credit to purchase things that we not only don’t need, but that don’t put us in a better financial position in the long run. The obvious examples here are consumable products.
If you use e.g. credit cards to do your shopping, and don’t pay the full balance on the cards at the end of the month, the chances are that you’re accumulating debt for things that are not going to offer you financial value in the future – these are ‘bad’ debts.
Given that bad debts are not going to do your financial situation any favours overall, it’s best where possible to pay them off as soon as you can. Paying interest on these types of purchases is just a drain on your resources that offers you no real return. Many people are of the opinion that ‘bad’ debts like these are the result of living ‘beyond your means’ and purchasing things that you do not really need straight away.
In the days before it was as easy as it is now to get credit, people saved up for purchases that they didn’t have the funds to hand for, whereas we are able to just buy them whenever we choose. The downside is that we end up paying over the odds for them, often many times the actual cost by the time we pay the debt off.
If you have a lot of bad debts and want to get rid of them, it may be worth considering a consolidation loan. In this case, you should look for a deal that is not only going to give you one monthly payment instead of several, but also one that will save you money.
A good deal in a consolidation loan will reduce the amount of interest that you pay off over the course of the loan, hopefully reducing your monthly bills as well. Make sure you calculate what the cost will be over the whole term of the loan, as well as how long that term is likely to be. Bear in mind that many lenders will offer an interest rate that is attractive, but that only lasts for the first period of the loan, subsequently increasing, often by a substantial amount.
If you do get a consolidation loan, it’s best to try not to then incur any more ‘bad’ debts, undoing the advantage that the loan has afforded you.