MoneyMagpie Editor and financial expert Vicky Parry explains how some debt can be beneficial to you in the long run
We spend our lives trying to not be in debt – but some debt can be a good thing.
For example, having a line of credit that you pay off each month can boost your credit report and improve your chances of getting a mortgage. Like everything else, when you’re looking at creating a line of credit or a debt source, make sure you shop around to find the best deals before committing.
When is a good debt a bad one?
First things first: living an entirely debt-free live is the ideal we should aim for. However, that can mean having lines of credit that you pay off in full each month, rather than “having millions in the bank”. A good debt – like the ones below – can quickly spiral into a bad one. A bad debt is one that you struggle to make monthly repayments on, that costs more in interest than repayment balances, or that causes you financial anxiety. Let’s take a look at examples of good debt, and how to manage them to make sure they don’t spiral into bad debt.
Credit card debt
Credit card debt is the most common type of debt, and it’s easy to manage. As long as you pay your credit card off in full every month, you’re building a strong track record with credit reference agencies as a responsible borrower. This can benefit you in the future if you need to apply for larger loans such as a mortgage.
However, it’s not about maxing out your credit limit each month. Aim to use between 10-20% of your total credit limit and pay it off in full every statement. This is because credit reference agencies look at how you use your debt: are you stretching yourself to the limit every month, or using a reasonable and affordable amount? Playing the game over time helps you access better interest rates and higher credit limits.
Balance transfer card debt
In the same vein as credit cards, balance transfer cards can be good debt. This is because the debt is just the amount you owe (for a set period of time) without accruing interest. As long as you make repayments each month and clear the debt within the interest-free period, it’s a good debt.
It’s even better if you look at it hand-in-hand with savings in a high interest account. You might be able to clear your credit card debt in one fell swoop with your savings – but this can damage your credit score. However, keeping your savings in a high-interest account and paying off a regular amount on your balance transfer card each month not only maintains your credit score but also makes your money work harder for you. Clearing £1000 of interest-free debt in one go means you’re not letting that £1000 work for you – but paying £100 a month instead leaves the rest of your savings to continue earning that interest. Just make sure you clear the full balance transfer card amount before the end of the interest-free period.
Student loan debt
The majority of people who have been to university in the past couple of decades have some level of student loan debt. This is a manageable debt that is paid off through your earnings every month, although you can pay it off faster with extra payments if you can afford it.
Student loan debt isn’t looked at negatively by lenders as other debt types, like overdrafts. Like mortgages, it’s a common debt type that people are actively encouraged to get. So, unless you default on your repayments (which impacts your credit score), it’s a debt you don’t have to worry about.
Mortgage debt
Buying your first home is scary – even more so when you look at mortgage calculators and see how much interest costs on top of the loan. However, it is one of the most stable types of debt as it is very long-term and proves you’re a responsible borrower (unless you default on a payment).
Mortgages can work out cheaper than renting, but it depends on the type of mortgage you get and the loan-to-value ratio. A lower LTV ratio will reduce your long-term debt, but it isn’t always possible with rising house prices making it hard for people to save a large deposit.
If you ever experience difficulties with paying your mortgage, don’t put your head in the sand about it. Be proactive and talk to your mortgage provider as soon as you feel the pinch: they may be able to give you an interest rate freeze or holiday, or offer another solution to give you breathing space.
What to do if debt is overwhelming you
All it takes is for one small life change to turn any of these good debts into bad ones. The debt spiral can take hold quickly if you don’t know how to handle it. So, the moment you feel like your debt is becoming unmanageable, take some steps to tackle it.
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Create a budget and cut unnecessary spending
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Look at all of your debts and interest rates to prioritise which ones to pay off first (your mortgage then the highest interest rate debt should get the biggest repayment each month).
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Ask lenders to freeze your interest or have a payment holiday.
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Look for ways to boost your income.
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Speak to a debt management charity for help before it becomes too overwhelming.
Debt is not something to be ashamed of, especially at a time when costs continue to rise while salaries stay stagnant.
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