Well-known short-term lender Wonga SA advises consumers, before taking out a loan, to consider whether they are borrowing for the right reasons.
The company’s recent survey of more than 18,000 customers showed that 83.7% of people would borrow to fund a house purchase, 68.8% would take out a loan for a car and 58.6% would enter into a loan to fund the costs of a university education. Meanwhile, 5.1% would borrow for a holiday and 4.5% would take out a loan to fund luxury items such as gadgets, technology or fashion.
It is fairly evident that the first three are ‘good’ reasons for borrowing, while the other two are ‘bad’ reasons for getting into debt.
Whilst you shouldn’t use it as a rule to be followed in all circumstances, debt is often said to be good if the loan is to fund some sort of investment in the future. Getting a university degree should boost your earnings potential, give you a good career and give you the means to pay back the debt. Once you have bought a house, the property should hopefully increase in value.
Borrowing to pay for luxury items is widely accepted to be bad debt. Other examples of bad debt include:
● Borrowing to repay existing debts, unless you can clearly demonstrate that the repayments on the new loan will save you money when compared to the current loan. Otherwise, you are simply exchanging one form of debt for another
● Borrowing to meet essential everyday expenditure. If your expenditure is greater than your income, the initial temptation may be to borrow money to plug the gap. However, this is never a good idea. If you can’t pay your regular bills right now, how will you manage next month, when your level of income is likely to be the same, but your expenditure will be even higher? Once the loan is in force in the following month, you will need to make a debt repayment in addition to all the things you usually spend money on
Whilst it was mentioned above as being an example of a ‘good loan’, a car loan can in certain circumstances be a bad debt. For many people, a car is all but essential to allow them to get to work, get to the shops, visit family and friends etc. Given that many people do not have the means to pay for a car upfront, taking out a car loan is often the only option. However, a car loan can be bad debt if you have splashed out on a luxury car that you don’t really need, and which you realistically can’t afford.
As with any other form of borrowing, before taking out a car loan you need to put together a budget, where you work out what you already spend on food, clothing, transport and other areas, and then work out how much you can realistically afford to pay in debt repayments.
Additionally, any loan which you cannot realistically repay, or where meeting the repayments cause anxiety and stress, is also likely to be a ‘bad’ loan.