4.1 Personal debt

In the video Martin Lewis – money saving expert and media adviser on financial management – engages in a discussion with an audience about good and bad debt.

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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.

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Debt is a topical issue, and for many households a sensitive and problematic one. But it’s necessary to take a measured approach and recognise, as Martin Lewis demonstrates, that all debts are not bad debts.

Debt arises when we borrow money, and there are many forms of borrowing – from credit card debt to bank overdrafts, bank loans, student loans (to finance higher education) and mortgages (to finance the purchase of property or land). Debt can be used to provide finance for everything from day-to-day spending (you’ll be aware of the growth in recent years of ‘payday’ loans) to holidays and to items we use over a number of years, such as furniture, cars and our homes.

Since 1993 the aggregate (total) value of personal debt has risen 3.5 times to a total of £1.56 trillion. The vast majority – around 87% – of this is ‘secured debt’, money lent against the security of property or other assets that the lenders can take possession of if the borrower fails to repay the money that has been lent to them. The rest is unsecured debt, which since the late 2000s has actually fallen slightly in aggregate value.

The UK has seen some dramatic swings in interest rates in recent decades – from the highs of the early 1980s to the historic lows we’re currently witnessing. So getting to grips with the factors that determine how much we have to pay on our debts is an essential aspect of financial planning.