There are Three broad categories of debt:
- loans and overdrafts.
- finance secured on assets.
- fixed-income debt securities.
Each one is due it’s own paragraph or 2, maybe we do another post like this and explain those future but I am going to break them down a little further, separating them into 3 different, simpler, categories. Hoping to make a little more sense of debt for those who are thinking of taking some on or just want a better basic understanding.
Usually consist of a solid, guaranteed Investment.
I could get into a few examples but that would require a lot of math and would become very boring very quickly.
The basic principle is;
The money you borrow is making more money then the interest rate plus the amount you pay back each month. I know I said I would skip the math but I’ll give a super quick example. Lets say there’s an investment that will pay you 500 a month (including all expenses etc). owning that thing means you have to take out a loan (Paying £250 a month for x amount of months. Remembering here the interest on the loan matters) Means you make profit of £250 a month.
Of course there’s other things to look out for (like the interest rate and how stable that 500 is etc) The basic principle remains. Borrowing money to make more money than if you were not able to make that same investment is good debt. It’s sounds complicated but understand the concept can improve your understanding.
Imagine the monthly payback rate and the interest rate as an expense to your investment. To live in a house your going to have to pay property taxes, rent or bills. Think of this in the same way. Figure out from that if it’s a good/bad investment (debt).
This could be things like a mortgage for a rental property (Make sure you do your own research in these areas, in no way does this resemble financial advice. I’m just telling you the difference between good and bad debt).
Some people got this unfortunate relationship with debt, that it’s all bad. Stay away and don’t own a credit card or anything. (Dave ramsey being a prime example)For some people, I would have to agree. I don’t think they would be able for credit. People my age is (usually) a prime example.
They don’t fully understand what their student loans are actually going to cost them. They don’t know their interest rate. They don’t know if a future job is going to able to pay them off, they don’t know if they want that particular job in 5 or so years and don’t fully know the type of commitment they are signing on for.
I don’t think they should be touching debt. I don’t think anyone, who doesn’t understand it, should be advised to do it.
The basic principle still stands, for me anyway…
If you can leverage it in your favour and make it work for you. Than It’s not as bad as a lot of people suggest.
Buying something with money you don’t have. There was a cringy quote (we all know) I was going add in here about impressing people you like and buying things we don’t need but the cringe becomes too real.
Those consumer products your putting on your credit card give you a boost of dopamine for a few minutes but wait a second and realise the actual cost of it.
Most credit card are in the 24% APR range but others go up to 30’s and 40’s. I even seen one in the 60’s at one point. For now, we will take the 24% as an example.
That 24 breaks down to you paying 2% a month. I don’t want to get caught up in numbers but that cool car you bought or that new monitor just cost you more than £1,000 if you didn’t pay it off in the dedicated time period.
I been here and understand it more than you know. I don’t claim to be the poorest person ever and I don’t say that to bring sympathy or anything like that.
I say it because I understand necessary debt. Sometimes there is nothing you can do. My best advice I can give it find that cheapest rate of interest and pay it off asap. I hope this shows you how important a emergency fund is and if you have to go down this way and take on bad debt… I don’t even need to explain why.
I will also say to take a look at your expense. Do you really need that spotify or that netflix sub for the next few months or those £200–£300 shoes on your feet. There nice but staying out of debt is nicer. Trust me.
Lauren at ‘Adulting is easy’ had some interesting insights to add:
Debt can be a controversial topic in personal finance circles because high debt levels mean an increased risk of not being able to pay back money owed. Most would agree using debt to buy belongings whose value decreases over time is the wrong thing to do. For example, you should pay for belongings like furniture and clothing outright and buying them used whenever possible.
To me, purchasing items outright can mean either paying cash or paying with a credit card that will be paid off within one month. In some personal finance circles, it is not advisable to use a credit card, however, if you are disciplined enough to pay the card off every month, there are benefits (Highly suggest you read the article) to using it, like receiving cash back.
Perhaps the exception to borrowing to buy a depreciating asset is a vehicle because it is difficult to have the cash necessary to buy even a reliable used car up front. If you are unable to pay cash for a car, you should buy a practical one and pay it off within 3 years. Then, keep that car for as long as you can so you can maximize your ability to save and invest.
Using debt to buy appreciating assets can be a good thing, but this is one of those controversial points. Young working adults (like my husband and me) can bear to carry a low-interest mortgage on their primary residence, which allows them to save money to invest and benefit from modest appreciation on their home. In our case, we invest in the stock market and real estate without having to borrow to do so.
How much debt you choose to carry is a personal decision everyone must make, and it is important to find what works for your budget, goals, and peace of mind. In general, don’t use debt to buy depreciating assets, and take care when using it to buy appreciating ones so that you don’t end up owing more than you can comfortably pay.
She continues to highlight the 3 key issues relating to debt
- you are buying something now and paying for it with future earnings,
- you are paying more for the item than it is worth because of interest on the loan.
- your future cash flows will be limited by payments, leaving less money to save and invest.
By: Lauren Keen Aumond, creator of the Adulting Is Easy blog and podcast.
Check out her website and Twitter!
Check out her amazing podcast here.
That concludes what we got on debt. I’m thinking of making this a series of blog posts where I get people to share their experiences, tips and opinion relating to debt. Let me know what you think and if you got anything to add? Leave a comment, send us an Email at firstname.lastname@example.org or leave us a DM over on twitter or facebook.
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