If you’re borrowing intelligently, you need to understand the choices, and the advantages of each form of lending. There are several kinds of debt, and each is appropriate for different needs and situations.
Open credit means credit where there is no obligation to pay off the principal, so long as the interest payments are made. Open credit includes credit cards. These are usually very expensive if the balance is not paid off within the interest-free period, but can be used very cleverly to manage your budget.
There is one big plus to regularly using (and paying off) a credit card – it’s the single greatest way to quickly build a credit rating, especially with the issuing institution. Open credit also includes agreed overdrafts with your bank or credit union – these are usually much cheaper than a credit card and also help to build your credit rating, though more slowly.
Closed credit means credit which is paid back in set instalments over a set period of time until you have paid it off. It includes both secured loans like a mortgage or a car loan, and unsecured loans you might take out for a holiday or to cover the costs of a vocational training course for example.
Never forget that “secured” really means secured: If you miss too many payments, your car or house will be repossessed by the lender, and you may suffer more than just an impaired credit history!
The question to ask yourself every single time you consider borrowing is whether you’re incurring “good debt” or “bad debt” – in other words, are you borrowing to purchase an asset that will return more than you are paying for the money?
Other forms of credit
Other forms of credit include: payday loans, which you should avoid, here’s a great podcast on why they’re evil; rent-to-buy schemes, which you should consider only for income generating investments; and informal loans from family and friends.
Informal loans from friends and family are an interesting mix of good and bad. Advantages include the fact interest may not be charged, your repayments can be flexible, and you may be able to access this source of lending when conventional credit is not available (for example, because you have not had the chance to build up a credit history yet). Disadvantages include the fact these loans can be hard to keep track of as there is no formal paperwork, do not help you build a credit history, the informal loan might be suddenly “called in” due to unexpected circumstances, and any misunderstandings or miscommunications could ruin a friendship or family forever, not to mention the impacts these kinds of loans will have on your budget.
A final form of debt to take into account is employer-arranged credit. For example, where your company has an arrangement with a bank to negotiate a special rate for staff on automobile loans which are purchased via salary sacrifice schemes. These are often good value, but don’t forget to include them when calculating your debt servicing levels as well as your budget!
Use it or lose it!
“Good debt” is only good if you actually use it.
Whether it’s a piece of machinery allowing you to double your business productivity, or an investment property you’re self-managing for capital growth – if you aren’t proactive and engaged, you’ll end up blowing your budget – and by definition this is money you’re already paying interest for!
Bill Butler can help you not once, but twice here – we’ll make sure you never miss a payment and we’ll also free up your time so you can be proactive and engaged to make sure any assets which you borrowed for, generate the return you need.
This blog forms part of our debt is good series – make sure to check out our next blog – why debt is healthy next week.
Lead Thought Provoker
Jay began his career in London with Rabobank, CLS bank and a Lloyd’s of London syndicate. Jay’s work has spanned corporate communications, content editing, newspaper articles, courseware, blogging, policy drafting, technical writing, and a regular crossword. He is passionate about 8-bit tunes, self-improvement, and the Oxford comma.