Finance Blog

Understanding Debt: What is Good Debt?

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These days it’s impossible to avoid adverts for all manner of personal finance products. Whether it’s online, on the television or even on the radio, we are constantly bombarded with messages telling us just how attractive this ever-increasing range of credit options can be. On the face of it, many of these messages sound extremely appealing. Some advertisers will even try to convince you that the products they’re offering are low risk or even risk-free. The truth is, they’re not. All debt carries risk, but there are still certain circumstances when a debt can be beneficial.

What is a good debt?

A ‘good debt’ is considered to be the type of debt that delivers a return on investment that’s greater than the cost of borrowing money. This does not have to be a monetary return necessarily, but a return that ultimately makes the cost of the debt worthwhile. For example:

  • University debt – Going to a top South African university will certain cost you, but the theory is that you’ll make a better living when you graduate, making the return on the investment worthwhile. You’ll then be able to comfortably repay the loan.
  • Housing debt – A mortgage is likely to be the biggest debt you ever take on, but ultimately, the return on investment is usually worth it. Not only will you own the property after a certain number of years, but it could also increase in value.
  • Business debt – A business investment is one that will hopefully increase your returns further down the line. As the business grows, the loan can be repaid more easily.

Understanding debt

We tend to be taught that debt is a bad thing, but if you have a good understanding of debt and how it should and shouldn’t be used, it can prove to be a sensible investment. The key when making these crucial decisions is to understand debt and the full range of credit options that are out there.

A recent financial literacy survey by the short term lender Wonga South Africa, has shown just how much work still needs to be done. The survey of 18,000 customers found that 77 percent didn’t look at the interest rates and fees on credit applications. That shocking admission shows just how far financial literacy in South Africa has to go.

However, there did seem to be a better understanding of just what constitutes a good and bad debt. 83.7 percent of the survey’s respondents said they would take out credit to buy a house, while 58.6 percent said they would use credit to pay for a university education. This compared favourably to the 5 percent and 4.5 percent who said they would borrow to pay for a holiday or buy gadgets and technology respectively.

Cash is always the better option

Regardless of how ‘good’ a debt might be, the interest and fees attached mean you always end up paying more than if you could have made the purchase in cash. Unfortunately, not all of us have enough cash to pay for a university education upfront, which is when the difficult decisions need to be made.

Taking the time to understand and explore all the credit options available to you is incredibly important. This will help you calculate the true cost of the debt, and properly consider whether the anticipated return is really worth it in the long run.