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debt wrecking ball

American billionaire Mark Cuban recently said in an interview that “paying off your debt can be the best investment you can make”.

As with most of the tools so far, this blog is about understanding. Debt can often be accompanied by judgment and negative connotations. But the truth is that not all debt is bad. That said, you need to understand its true nature.

Not all debt is Bad….

In some cases, debt can be a sensible investment in your future and put you in a better financial position over the long term.

An obvious example is taking out a mortgage. It is highly unlikely that you would be able to afford to buy your first home outright and a mortgage enables you to purchase a home with a smaller lump sum (the deposit). The remaining amount paid down over a 25-30 year timescale in regular and affordable payments.

Two other examples are student loans or loans to finance your own business, basically it could be anything that should leave you better off in the long-term. You will still have an interest cost to pay but it serves as an investment into your long-term financial stability.

…. But some of it definitely is

High cost debt can be the biggest drain on your wealth. It doesn’t offer any prospect of paying for itself in the future and the higher interest rates generally mean that it can spiral far quicker than people expect.

High cost debt can be anything from credit cards, store cards and pay day lenders and they are generally intended for the short term. Short term lending in of itself isn’t a bad thing. But when there isn’t a realistic plan in place to pay it back, or you couldn’t afford to borrow in the first place, it can lead to real problems.

Identifying your financial goals

In simple terms, if the interest rate on your high cost debt is more than the return you get on an investment, then you are actually making an overall loss. We’ve already established that compound interest can be your biggest ally in building wealth. Unfortunately, it can be your worst enemy if left to work against you.

In my earlier blog “Getting Started – The 50/20/30 Rule”, I explained a very simple approach to budgeting. In short, you break apart your after tax income each month into three pots;

  • 50% goes towards living expenses and essentials.
  • 20% is put towards your future financial goals.
  • 30% can then be used for spending on whatever you want

When considering your future financial goals, identifying expensive debt should be a priority before you even consider investing. To get a better understanding of the impact debt could have on your finances, seek professional advice from a qualified adviser.

 

If you are struggling with debt or require debt advice, please contact the following organisations, that are able to offer free and impartial advice on how to tackle debts:

Disclaimer: The information provided through the Equilibrium website is based on our opinion and is for general information purposes only. It is not and should not be construed as financial advice.