Personal debt: not all debt is bad debt

As personal debt figures continue to rise for households across the country, the Bank of England is keen to act to ensure the total debt of UK households does not rise much further. As the national debt hits £1.5 trillion, there have been warnings from the Bank, regulators and debt charities about the amount of money many people across the UK currently owe and in some cases, are struggling with.

However, not all debt is “bad” debt and the main question to ask yourself before borrowing any money is that debt affordable and manageable for me in my current situation?

“Good debts”

Loans taken out to buy a house, grow your business or invest in your future education are usually seen as the gains outweighing the debt you owe. This is because, in these instances, you are likely to have taken out the loan as a way of investing in your future by enhancing your career prospects or allowing you to own a home for you and your family.

As a result, these types of loans and debts are likely to be classed as “good” debts, especially by those who took the debt out in the first place. If you researched the loan and made sure you found the best deal then you will probably view yourself as better off in the long run.

However, the debt will need to be affordable for your current situation so that you can ensure you will pay back the debt, meet monthly repayments and find those repayments manageable for your current financial situation. If debts start to become unmanageable then this is when problems are likely to arise.

“Bad debts”

Using credit cards or a bank overdraft facility is ideal for covering unexpected expenses or short term cash shortages. The danger signs are when you need to rely on credit to meet regular expenses and outgoings or where you are permanently in your overdraft facility – particularly if you are getting deeper in debt every month.

If you know that you can afford the repayments and manage your money then something such as a credit card can be a useful option to boost your affordability and grow your credit report as long as you meet the minimum repayment each month and pay down balances as quickly as you can.

The Bank of England is worried that people are taking out credit cards and loans to meet costs such as regular bills, breakdowns or other necessities which can be a sign of a financial struggle to manage household or personal finances without the fall back of credit.

In a perfect world we would all:

• Budget to ensure we could cover all regular expenditure and routine outgoings from income
• Pay for larger items over a period of time providing we can afford the repayments
• Budget to save to cover unforeseen expenses

…but we don’t live in a perfect world and sometimes despite our best efforts what seemed like a  good loan when we arranged it suddenly turns bad perhaps because of changed circumstances.

So how do you deal with a debt when it has turned bad?

1. Manage your budget – Spend time creating a budget, or updating your current one, to clearly see your monthly income, the amount of money you are spending a month and where you are spending this money. By doing this, you may find areas where you can cut back and reallocate that money towards paying off your debts.
2. If you can reduce your borrowing – Pay off first the debt that will reduce your monthly outgoings most. This is often, but not always, the one with the highest interest rate. However, repaying loans which are over a short term will benefit your cash flow most.
3. Balance transfer if you can – With credit cards you can stop your debt from spiralling out of control by transferring the balance to a 0% interest rate card, preferably a 24 month 0% rate. This will ensure that no interest is added to your debt so the money you owe stops growing making it a lot easier to tackle but always be aware of the fees which can be expensive and crippling for some.
4. Talk to your lender – Always talk to your lender as you may be able to agree a payment plan with them with lower repayments, a longer repayment period or a freeze on the interest rate for a couple of months. Many lenders are willing to help their customers so if you get in touch early and are honest about your financial situation, they are more likely to look more favourably on you.
5. Get in touch with us – If after all this you are still struggling with your debts, get in touch with us. Our friendly, knowledgeable advisers will listen to your cash problems, provide you with the solution best suited to you and help you get your finances back on track by dealing with your debts.

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