Mortgage Agent Oakley Patterson Talks Debt — and Why it isn’t Always a Bad Thing
Learning the difference between good debt and bad debt allows you to learn how to leverage money and minimize your expenses. Real estate is the best way to accomplish this and that is why it has been Oakley’s focus for over 6 years. Oakley is currently a Mortgage Agent working alongside Gerard serving the counties of Huron and Bruce.
There’s no way around it — debt gets a bad rap. The saying ‘No debt is the best debt’ amplifies a common way of thinking that you’ve likely heard some variation of as you’ve embarked on your own personal lending journey. While it could be said that this is the safest view, the reality is that thinking all debt is inherently bad could lead you to miss out on great investment opportunities.
Debt: What is it?
Debt can be divided into four main categories:
● Secured debt – such as a car loan
● Unsecured debt – such as a credit card
● Revolving debt – such as a Home Equity Line of Credit
● Mortgages – such as a loan to purchase a house
How do we differentiate between these types? For starters, secured debt is debt that uses collateral to back it, like a car loan. On the other hand, unsecured debt has no collateral, making it a greater risk for investors. This often results in a higher interest rate being charged.
Next we have revolving debt, which is an agreement between the borrower and the lender that allows the borrower to freely spend to a specific limit. These agreements can be unsecured, like a credit card, or secured, like a line of credit that is linked to a guaranteed investment product.
Finally, we have mortgages. Mortgages are the largest and most common form of debt. By definition, a mortgage is a secured loan that typically has a lower interest rate than all other forms of debt. Mortgages may be issued over amortizations up to 30 years.
To tell the difference between good debt and bad debt, it is key to look at where the debt is being placed.
Which Debt is Good Debt?
As a general rule, a debt can be deemed ‘good’ when it is used to purchase something that will sustain or appreciate in value. Need examples? Have a look at these:
● A mortgage – Purchasing a home is a great use of debt. The average increase in property value is 2% per year. This changes due to local market fluctuations but it almost always increases over time.
● Your own business – Using a loan to start or expand your own business can be extremely valuable. It’s true that starting a business is a lot of work and it does include risks, but it can also be very mentally, and physically rewarding.
● Education – In general, education gives an individual a chance to expand their earning potential. In most cases, education also makes finding employment easier.
Which Debt Should You Avoid?
Bad debt is a depreciating asset. It accumulates when you purchase something that will decrease in value using borrowed funds. Curious about what constitutes bad debt? We’ve gathered some popular answers for you here:
● Cars – You likely need to use a car everyday. You may even need to borrow money to purchase one. This does not mean that you need to buy a brand new car. From a financial perspective, a car loan is not always a great investment. On average, a new vehicle loses around 20% to 30% of its value by the end of the first year of ownership. From years two to six, depreciation ranges from 15% to 18% per year. You can expect a car to lose 60% of it’s value in the first five years.
● Clothes and consumables – Clothes depreciate an average of 50% of what consumers pay for them. If you use a credit card to purchase clothes or food, you’ll be doing yourself a solid if you pay the card off in full at the end of each month. This way, you can avoid interest charges. Credit Cards normally have the highest interest cost. ● Vacations – using credit card debt to go on vacation.
How to Avoid Bad Debt
So, now you know what constitutes ‘bad’ or ‘good’ debt. There’s no reason to be terrified of carrying debt. In fact, from a credit perspective, those with absolutely no debt history may have almost as hard a time obtaining credit products as those with debts they haven’t honoured.
As you head out into the wild world of lending, we advise that you keep these key points in mind:
- Only use a credit card when you can pay the balance off in full each month. Doing this will not only build your credit score, but it will allow you to save money on interest payments.
- When purchasing a depreciating asset, such as a car, use cash whenever possible and avoid buying brand-new.
- If ever you reach a point where you are paying one debt product with funds from another debt product, it is time to look at major budget changes including the closing of some products, selling assets and obtaining a consolidation loan if possible.
MAKE SMART DEBT CHOICES
Looking for financial guidance as you prepare for a large purchase in your future? Our team is here to help. We educate clients, giving them sound advice so they can situate themselves in the best possible position for future investments — including buying their first home!
Have a debt question that you’re worried may affect your eligibility for a mortgage? Give us a call or send us an email and we will do our absolute best to help you on your journey!
