Bad debt could be defined as debt that prevents you from achieving your future goals. And as the old proverb says, ‘an ounce of prevention is worth a pound of cure.’

What is 'bad' debt?

Some characteristics of ‘bad’ debt include:

• It is used to purchase depreciating assets. Furniture, new cars, electrical goods and many other consumer items fall substantially in value as soon as they leave the showroom floor. As soon as you buy them, the amount you owe is greater than the value of what you have just purchased.
  
  
• It incurs high rates of interest. High interest rates are often charged on credit cards, store hire-purchase arrangements and some personal loans. Interest expenses on some loans can far exceed the original amount borrowed. 
  
  
• It is inflexible. With fixed term loans, you may be locked in to long-term payments. Substantial fees may be charged for early repayment. You may end up paying much more over the course of the loan than you need to.

Before borrowing money

Before you are borrowing money, ask yourself:

• How will this purchase improve my life? If you can’t come up with an answer that satisfies you, perhaps you don’t need to make the purchase.
  
  
• Is borrowing the best way to pay for it? If the amount of the loan exceeds the value of the purchase, it might be better to save up for the purchase, if this is an option.
  
  
• Can I borrow at a lower cost? The higher the interest rate, the greater the cost of the purchase. It pays to shop around for the lowest interest rate.

Not all debt is bad. Some forms of borrowing help to improve our lifestyle and financial security. A mortgage on a home or an investment loan may be forms of ‘good’ debt, but only if certain conditions are met. Learn more about managing debt.