You’ve probably heard that there’s “good debt” and “bad debt”. While this is true, it’s really your attitude towards borrowing and budgeting that will determine if debt is actually good or bad. Debt that is irresponsibly managed will lead to debt management problems, no matter the reason for taking it out in the first place.
“While no debt is always preferable, there are some debts that offer you the opportunity to increase your wealth and these are considered good debt. Typically, using debt for education, home renovations or to buy a home are classified in the good debt category,” Jeff Schwartz, Executive Director, Consolidated Credit Counseling Services of Canada.
“However, if too much debt is taken out without being part of an overall financial plan or is mismanaged, that good debt becomes bad debt in a hurry” says Schwartz.
Here’s how to avoid having your good debt turn into bad debt.
Anticipate other expenses
One way to keep your debt under control is to anticipate all the costs. For example, if you’re taking out a student loan, how will you pay for additional expenses that might arise throughout your education years? If you are borrowing to buy a home, do you have enough set aside for home repairs and maintenance?
If you encounter emergency expenses, you’ll be forced to add to your current debt load to cover them if you don’t have cash on hand. Avoid this by budgeting carefully and including emergency savings as part of your good debt strategy.
Have a repayment plan
Only take out debt that you can afford to repay. That means you need to have a timeline in mind as to when you’ll be able to pay that debt in full. Set out a plan, based on your monthly budget that will allow you to repay this reasonably over time.
If you don’t have a timeline, or if you end up taking out additional debt, you will accrue far more interest than you should. That means that you’re effectively increasing your debt load because of carrying costs.
If you’re taking out student loans, it can be challenging to fully predict what your monthly income will be upon graduation, but you can ballpark it to keep your debt within a reasonable range.
How can I reduce debt?
You’re always advised to keep your borrowing to a minimum, regardless of the direction of the funds. The less you borrow, the more wiggle room you have in your budget, reducing your vulnerability. Try to find other ways to avoid over-leveraging yourself.
If you’re buying a home, increase your down payment, look for a smaller home or different housing type; if you’re taking out debt for home renovations, do it in stages to support your cash flow, or DIY where you can cut costs; if you’re taking out student loans, get a part-time job or cut costs to help reduce the amount of debt that you need.