Good Debt or Bad Debt

The debt debate has been raging over the past couple of weeks. How much is too much? What type of debt is ok to carry?

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Mark Carney, Canada’s Governor of the Bank of Canada, spoke up this week with strong warnings about the macroeconomic conditions which influence Canadian’s ability to borrow money. Timely, isn’t it, as many of us are confronted with the onslaught of spending temptations through the holiday shopping season?

But when the economists talk and use language like “adverse labour market shock” and “deterioration in the credit quality of loans to households,” it is sometimes difficult to understand what it means to you as an individual.

Does the warning apply to your own situation? What should you do about it? Here are a few tips to help you find out.

Not All Debt is the Same

When you are considering borrowing money for that next purchase, remember that there are good types of debt and bad types of debt.

Good Debt

“Good debt” is typically associated with the purchase of items or experiences that have ongoing or resale value. A home, for example, can end up being worth more when you sell it than when you bought it. It’s something that can appreciate in value and therefore, may be thought of as an investment. So a mortgage can be a good debt.

Also, borrowing to invest in your future by furthering your education or upgrading your professional skills usually has a good pay-off in career advancement and professional income. And student loans often have low interest rates. So, what you borrow to pay for an education is usually thought of as a good debt.

 

Bad Debt

Typically you accumulate “Bad debt” when you borrow or use credit to cover expenses or to buy optional luxury items. If you are using credit to pay for things you don’t really need or for a life-style you can’t afford, consider saving up for them first, instead. You may be surprised at how satisfying it can be to finally get something you’ve saved up for. And you won’t have to pay more for it than the sticker price because you won’t be paying interest charges for a loan.

How Much Debt is Too Much Debt?

With credit so easily available these days, and at historically low interest rates, it seems harmless to borrow now and pay later. But is it worth heeding this week’s warnings from the Bank of Canada – what is it that they see?

The Bank of Canada has noticed that many Canadians are moving into risky territory, carrying the maximum amount of household debt-to-disposable income. At 148.1%, this is 6.7 per cent higher than last year. This means, in simple terms, that if you earn $10,000 in disposable income per year, you are carrying almost $15,000 in debt. They are concerned that this may leave many individuals, and therefore Canada’s economy, at risk.

While economist and bankers are debating about whether this number represents good or bad debt for Canadian households, there are still some rules of thumb that can help you establish if you are running a tight financial ship.

According to Credit Counselling Canada, the following breakdown in spending as a percent of your income should keep you afloat:

  • 35% – House expenses (rent or mortgage)
  • 15% – Unsecured lending
  • 15% – Utilities
  • 10% – Savings
  • 25% – Day-to-day living expenses

If your debt is becoming too much to handle and you feel like you’re drowning, get help. There are lots of unbiased resources to help you get started down the right path.

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One Response to Good Debt or Bad Debt

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