Debt is one of the biggest stresses for people. It puts pressure on their finances and makes them feel guilty about how it was accrued in the first place. Plus, it brings on anxiety as you wonder how you are going to be able to pay it back.
But debt itself is not necessarily a bad thing. It enables us to buy things that we need now. The problem with debt is when you borrow money to spend on luxuries that you can’t afford or borrow at high interest rates.
I’ve heard people frame debt as ‘good’ or ‘bad’. For example, a bad debt could be a credit debt on a higher interest rate. A good debt could be a mortgage.
I don’t think this ‘bad’ and ‘good’ approach to debt is healthy. Thinking of it as bad is never going to make you feel good and the feelings of stress will only increase with this mindset.
Instead, think of debt as ‘helpful’ or ‘unhelpful’.
A mortgage is a helpful debt to have. It bought you a house that you couldn’t afford to buy outright. Mortgages tend to have lower interest rates and the affordable payments are spread out over a longer term to pay off both the interest and the capital. Hopefully, the asset you bought will increase in value too.
An unhelpful debt is typically a credit card on a high-interest rate with high monthly payments. All you are doing here is servicing the debt. This is a real drain on resources as you aren’t paying off capital.
I’m afraid it’s not as easy as looking to see if a debt has a high or low interest rate.
It’s true that the lower the interest rate is the less you will pay but if you have a mortgage rate that is 1.5% you have massively overstretched yourself. When you can’t afford the repayments then it becomes an unhelpful debt.
Ask yourself “What will taking on this debt enable me to achieve?”. If you realise that you’re going to be worse off in the long run then this is unhelpful. If the debt was to start a business, investing in yourself or helping to grow your firm, then it’s very helpful. It’s allowing you to increase your future earnings.
Impulse buys should come with a warning! These are the things that tend to come with a high interest rate and it’s unlikely that you’ve had time to create a realistic repayment plan. If you can’t afford to make the monthly payments, it’s unhelpful. Step away from that Harley-Davidson!
When you are thinking about borrowing money consider whether the purchase is essential. Do you NEED it, or do you just WANT it? If it’s a want, is there another way you could pay for it by saving up? There are often opportunities other than to get into debt.
Find a bigger purpose. One of my clients had nearly £40,000 in non-mortgage debt. With my help, they gained clarity on the bigger picture and what they wanted in their life. This monthly payment was holding them back. Without this they could start saving towards their family’s dream lifestyle. This focus enabled them to put a plan in place to pay off the debt within three years. With effort, they actually paid it back in under 12 months. It’s easier to say no when there is a bigger yes.
The debt avalanche: Pay off the balance with the highest interest rate. Although paying off the highest debt makes the most sense from an interest perspective, it sometimes feels like you are not making progress. This can make you disheartened so that you stop trying.
The debt snowball technique: Pay off the smallest debt first whilst maintaining minimum payments on the others. Once you have paid off the smallest debt you can move on to the next and so on. This has the advantage of seeing your debt reduced. The visible progress will spur you on to stay motivated.
If you are thinking of taking on additional debt it’s important to think about all of your options. Review your spending plan and ensure it’s manageable. If you have existing debt and feel bad about it cut yourself some slack. Review your spending and put a plan in place to clear your debt. Focus on the feeling of being debt free and imagine what you’d do with your spare cash!
