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Good and bad debt

July 19, 2016

finance

 

Debt is never far from the news these days. Here are some of the similarities and important differences between government and personal debt.

The comparison to the kinds of debts held by governments and the problems of that and personal financial responsibility is an understandable one to make. The numbers involved, after all, are so astronomically high that it is hard for anybody to get their head around.

Image via Sandra Fortner (Pinterest)

Government borrowing is frequently described as being like a person borrowing to live beyond their means. The great advantage of this analogy is that it is simple and easy for anybody to understand.

We can all easily grasp this concept as it relates to our everyday experience. The big disadvantage to it though is that it does not really accurately reflect the reality of the situation as it actually is.

The biggest misconception is that governments are expected to pay off their debts in their entirety.
If an individual takes out a loan then they are expected to repay the whole thing, but his is not really the case with governments.

For governments the important thing is that borrowing can allow economic growth to continue, and being in debt is really no bar to this happening.

Some of the periods of most rapid growth in the economic history of both the United Kingdom and the USA have occurred at times in which the governments of these countries were heavily indebted.

With government borrowing whether debt is good or bad is a very complicated question.

It is not really one that can be answered with domestic finances as the frame of reference as there are exponentially more factors involved and concerns to be born in mind. For individuals though, the difference between good and bad debt is very easy to see.

Getting Personal

The only kind of debt that an individual can have that can really be seen as beneficial is that which is facilitating growth. The most obvious example of this is a mortgage. Paying off a mortgage rather than spending money in rent usually actually amounts to saving, with the increase in property prices over time sweetening the deal.

Another example of a personal debt that can be seen as being a good thing to get into are student loans. This is a controversial topic, but in theory at least borrowing money to fund an education is worth it because it allows greater income in the future.

Bad debt is also easy enough to understand in the realm of personal finances. The absolute worst are loans at exceedingly high rates of interest.

These tend to be for small amounts and are intended to be paid back over a short period of time. They can however quickly spiral out of control, especially as it is the financially disorganised who are likely to need them rather than having some cash in a savings account to smooth out cash flow issues.

Has getting into debt helped or hurt your finances? Share your experiences in the comments if that’s your bag.
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