4. Debt

Debt

Good debt, bad debt, and how to make it work for you

Not all debt is bad. Borrowing money can be very useful, for example getting a mortgage to buy a house, taking out a student loan to go to university, or using a credit card to buy something you need right now and will be able to pay off in a month or two. However debt can also cause big financial problems for people who take out too much or find they can’t pay it back.

Most of us have a pretty good idea of what good debt and bad debt is. Good debt is debt we’ve planned for, that we know we can afford, often for an investment like a house or to go to university. Bad debt is debt we struggle or are unable to repay. Bad debt tends to have a much higher interest rate and is often started by borrowing on impulse or as a last resort, but it can come in many forms.

Avoiding bad debt is key, as getting out of it can be very difficult.

In the video Martin Lewis – money saving expert and TV personality – discusses with an audience about good and bad debt:

Download this video clip.Video player: mmm_for_squeezed_openlearncreatecourse_vid_1010.mp4
Copy this transcript to the clipboard
Print this transcript
Show transcript|Hide transcript

Transcript

MARTIN LEWIS
We're going to play the Good Debt, Bad Debt game. Okay, you're all going to have to engage and join with me and give me your breadcrumbs. So, it's very simple, if you think its good debt, you say good debt - so if you think its good debt you say...
AUDIENCE
Good debt.
MARTIN LEWIS
Now, come on room, you're all in suits, but we're going to do it properly, this was designed for 15 year olds, you can cope with it. If it's good debt you say...
AUDIENCE
Good debt.
MARTIN LEWIS
If it's bad debt you say...
AUDIENCE
Bad debt.
MARTIN LEWIS
Now we're warmed up, so let's get going. Right, it's very easy - question number one, designed for 15 year olds, but there's an important message that goes here, and I'm always fascinated to hear the response of the room.
Question number one: I've been saving up to get a mortgage, a place for me and my family to live. We've managed to get a big enough deposit, it's over 10%. We're looking for somewhere for the long term, not an investment. We're getting a fixed rate mortgage for five years. It's affordable and is actually cheaper than our current rent. Good debt, bad debt?
AUDIENCE
Good debt.
MARTIN LEWIS
Of course it's good debt, but, oh, lo and behold, look what we've just done room - we have said debt is good. What happened to our grand, parental, neither a borrower or a lender be, young Johnny? Well, it's gone out the window, because if you want to buy a house in our modern world, you're going to have to borrow it. If you want to go to university, you're going to have to get what we call debt - I would argue it isn't, but it's what we call the student loan. So, what we have to do now, within financial education, is embrace the complexities of our modern world. We have to teach: debt isn't bad, bad debt is bad. How do we give you the tools to make these decisions?
Question number two: I've just seen a holiday to Jamaica, it costs 19,000 pounds. I earn 5,000 pounds a year, but the payday loan company says they'll lend me the money at only 10% interest ... an hour. Good debt, bad debt?
AUDIENCE
Bad debt.
MARTIN LEWIS
Bad debt, of course. I'm not saying all debt is good - of course we need to say, when is it right, when is this an investment base, have you planned for it, budgeted, can you afford it, what are you going to get back, how's it going to enjoy the functionality of your life?
Question number three: I used to work in a big urban centre, a city if you like. I lost my job six months ago and it's been a real struggle to find a new one. This week, I've just been offered a new job - it's in the countryside. I'm going to have to move myself and my family, but we've found a house we can afford to live in.
The problem is we always went by public transport in the past, and where we're going to be living now, my kids school is seven miles in that direction and my work is eight miles in that direction. Before you get clever, one of my children is disabled and has a bad leg, so there's no cycling. This is the problem - I've got a very bad credit score because I've been unemployed, so it's going to cost me 20% APR to get the loan and that, the repayments over five years, are going to put me at the brink of affordability - I can just do it, just manage it on the first income. But I've got a three month probation period. If I get the job, if I don't get the car, I can't get the job. If I get the car and get the job but my three month probation goes, I'm totally gone because there's no way I can afford to pay this, and, frankly, it'll push me other the edge, I'll go bankrupt. Good debt, bad debt?
UNIDENTIFIED FEMALE
Is there a credit union?
MARTIN LEWIS
20% APR wouldn't be that bad at a credit union either, I'm afraid. Smart arse. Good debt, bad debt? Good debt, bad debt? Okay, you see, it wasn't quite as easy as you all thought it was going to be in the start. So, I'm going to give you a second to mull, and then we have very eminent people in this room. I'm going to ask for hands up. Hands up good and, anybody in here, and I'm watching and I'm vicious. I always need the butt of my jokes when I do a talk - if your hand doesn't go up in one of these options, that's you.
Okay, so I want good debt or bad debt, I don't care which one you choose to vote for as long as your hand goes up at some point. Cameraman, you're allowed off. Right. You're not. Good debt? Bad debt? Interesting. So, let me tell you the official money saving expert answer - it's grey debt, it's somewhere between good and bad. No, I set the questions, I can give the answer. But the really important point here, what's fascinating, by the way, is when you do this with 15 year olds, they are vastly, predominantly bad debt.
When you do to a normal group of adults, it's 50/50. When you do this to an educated room of financial people, it tends to be 75% plus good debt. Really interesting, because I think the riskaverse nature of kids - that very black and white, it's all black and white - no, borrowing is bad, I've been told borrowing's bad, I'm not going to get the debt. What adults tend to do, and in fact, if you said good debt because what you thought is: six months unemployed is too long, this is an opportunity,
I've got to take it, I've got trust in my, faith in myself that I'm going to get this job; I'm going to work hard to make sure it doesn't go wrong, so I'm going to make the best of my opportunity, because the downside, frankly isn't that much worse than I've got right now - okay, I'll be bankrupt, but I've got nothing, I've got no job, but the upside is an ability to feed my children and have a house and a better life - then correct - good debt was right for you. To those who said bad debt and thought, you know what, I don't really like bad debt, I believe in myself, I think I might get another job somewhere else more quickly and I'm willing to hold out a little bit longer to wait until it's a sensible time, and get something somewhere else, and I prefer to be debt-averse - congratulations, you got the right answer for you. To those who just stuck your hand in the air because I forced you to, you got it wrong.
Right, and what we have to do when we educate about debt, and the most important thing that this teaches us in life, and one of the most difficult things to educate children and adults - and I struggle with it, personally - is uncertainty. And now as an expert, people ask me all the time: what's going to happen to interest rates? What's going to happen to house prices? Should I buy a new house? I don't know. The only way I could know is with a crystal ball - they don't exist. And we're very bad, even, should I marry this woman, am I going to be in love with her for the rest of my life, is that going to work? You know, should I take the job I've been offered, I'm in a good job right now, this sounds better, but will I enjoy it?
That is dealing with uncertainty. And what we have to do is: plan for the worst, hope for the best, look at the upsides and downsides, take a risk and not beat ourselves up if it goes wrong. All of those of you who said good debt, if you hadn't got the probation period - didn't mean you made the wrong decision, because you didn't have those facts, and it was impossible for you to know those facts at the time. And yet in life we, as adults and children, we are given this idea that there's some sort of universality of right and wrong.
And perhaps, each of those three questions, well, they sound quite trivial - the first one is designed to teach you debt can be good - or at least necessary - the second one is designed to say, let's not be stupid when you borrow, and the third one's designed to say, sometimes there isn't a right answer. And actually, those lessons are very important for that sense.
End transcript
Download
 
Interactive feature not available in single page view (see it in standard view).

How can you avoid bad debt?

  1. Plan your borrowing. Often we borrow without making a clear decision to, such as dipping into an overdraft or spending on a credit card. There are usually much cheaper ways to borrow if you plan in advance and talk to your bank or local credit union beforehand.
  2. Only borrow what you can afford to repay, and never borrow for day-to-day spending. In the long run you need to live within your means. Borrowing can be useful to spread an unexpected expense over a few months, paying it back out of your usual income, or if you know you’ll be receiving enough money to pay it off in the future. However if you’re borrowing to fund day-to-day spending and aren’t about to receive extra money then you’re storing up bigger problems for the future.
  3. Avoid payday lending, weekly payment shops, and door-to-door lenders. This is almost always a far cheaper option.
  4. If you’re struggling to pay back a loan, talk to your bank or credit union as soon as possible. It may be a difficult conversation to have, but there is a fair bit they can do to help.
  5. If you get into difficulty don’t wait to get free debt advice. Talk to the StepChange or your local CAB (see the links to the websites below).

Extension: mortgages and other costs of buying a home.

Now move to next section: Do it Today List and a Final Thought