Guiding consumers since 2009

Part 1: The difference between good and bad debt

By Danielle van Wyk

For many South Africans their relationship with debt has been a toxic one dictated by hounding creditors, missed payments, and potentially expensive interest rates.

This is reflected by nearly half of credit-active consumers in South Africa having impaired credit records as a result of mismanagement of debt, says the National Credit Regulator (NCR).

But debt isn’t all bad – there’s good debt to be made too.

In the first part of our Debt-ucate series we explore the difference between good and bad debt and why debt is, in fact, necessary.

Tip: If you’re struggling with debt and need assistance in managing it, click here.

Whether it’s student loan debt, buying your first vehicle, or something as small as purchasing a cell phone on credit, very early on in one’s adult life you’re often forced to incur some or other debt.

This is also encouraged because building a sound credit record becomes important when wanting to qualify for larger credit such as a home loan later in life.

“Young earning individuals are often pressured into building a credit record but aren’t given the information or tools on how to do so responsibly. They’re told to make debt but don’t understand what that means or what kind of debt they should be looking into,” says an Absa in-branch consultant.

Therefore, it’s important that you understand both sides of the coin – taking out debt and paying it off.

What is considered bad debt?

Bad debt is something most earning South Africans are familiar with. This is debt accrued on non-essential items that quickly lose their value, do nothing to generate long-term income, and carry high interest rates such as credit card debt.

Short-term debt is the largest contributing factor to bad debt. This is typically offered by non-financial institutions – trapping desperate individuals with low qualifying criteria and later hitting them with expensive instalments.

These individuals are then often unable to manage payments to which they respond by taking out further credit to service their current debt. Needless to say, this is not financially sustainable and this typically leads to consumers becoming overindebted.

“The debt cycle in South Africa is terrifying. This is reflected through clients who’re increasingly under tremendous financial strain. Some of whom are using 64% of their net income to service their debt monthly.

“It’s clear that in the absence of real income growth, consumers are supplementing their income with unsecured lending on a large scale,” adds Debtbusters, a trusted South African debt counsellor.

These examples of bad debt include:

  1. Credit card debt: As one of the quickest ways to build a credit record, consumers often rack up expensive credit card debt as a result of high interest rates. If mismanaged this can lead to becoming overindebted.
  2. Personal loans: This the most common form of short-term debt and boasts expensive interest rates which are based on your credit record and score. They’re payable in instalments between two to five years.
  3. Vehicle loans: While this loan type is often unavoidable, a vehicle depreciates in value over time. This counteracts all the interest payments made while consumers are left to pay this debt off anywhere between five to seven years.
  4. Pay day loans: These short-term loans given to consumers boast extremely high service fees and interest rates, and the entire amount is typically payable by the next expected pay day.

The general rule to avoid bad debt is – if you can't afford it and you don't need it, don't buy it.

What’s also important to understand is that these bad debt examples or credit types do not always have to translate into becoming overindebted.

“While certain types of debt definitely have a bigger chance of negatively affecting your finances, it is up to the consumer to manage their debt responsibilities correctly,” adds an Absa consultant.

Should you be unable to do so, it’s both your right and responsibility to get trusted help.

Good debt and why it’s necessary

On the other hand, there’s good debt. This is considered debt that is beneficial to your wealth, meaning it generates income, or assists in adding long-term value to your life and future.

“Good debts can be seen as investments towards your future. It’s the kind of debt you want to take on,” says an Absa consultant.

Good debt is obtained by making wise decisions about your future, not for the sole purpose of having good debt. For example, you might make the decision to obtain your Master’s degree to increase your earning potential. Taking out a student loan, if you have no other way of financing your education, is a valid reason for taking on additional debt.

Examples of good debt include:

  1. Mortgage loans: Since property and houses usually appreciate in value and provide you with an asset that you can generate income on, a mortgage loan is considered an investment.
  2. Student loans: This type of loan allows individuals to further their education and better their career opportunities and income which is seen as an investment in their financial future.
  3. Business loans: This is typically taken out to either start or further a business. If your business succeeds and generates income over time this is considered an investment.

But even if certain debt is considered an investment, it’s still important to ensure that the debt you do take on is affordable and well managed.

To understand how you can lighten your debt load and pay less while servicing all your debt, click here.

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