Do you truly understand your debt? If you class yourself as in debt, do you really know what that means? Understanding your debt is the key to being debt free as not all debt was created equally…

The Oxford English dictionary defines debt as:

  1. a sum of money owed.
  2. the state of owing money.

The origin comes from the Latin word debitum meaning ‘something owed’. Essentially this means that when you are in debt, you are in debt to someone or a company who has agreed to lend you the money in the acknowledgement that it needs to be repaid at a later date.

The lender typically allows you to be in debt to them at a cost, as the lending comes with a certain amount of risk for them. Therefore you will agree to repay a percentage of additional interest on the debt.

Why You Don’t Understand Your Debt

Debt FreeThe basics of debt are simple: you borrowed money which you must repay. However, what many people do not understand is the type of debt which they have and how this differs from other forms of debt. This can often cause some confusion, so it is vital that you understand the difference between your debts.

All debt is debt and has to be repaid. To help you understand your debt a little more, lets divide your debt into two categories: Good Debt and Bad Debt.

Good Debt:

It can rightly be argued that ALL debt is bad, as it has been borrowed and must be repaid at some point. However, it can be virtually impossible for most of us to live without acquiring at debt some point in our life; the key is to keep this debt as ‘good’ as possible. Your good debt could include:

Mortgage: This is probably the biggest amount of debt that you will ever have in your life, as your mortgage is a loan which is secured against your home. It can be classed as a ‘good debt’ because most people would not be able to get their foot on the property ladder without a mortgage. The mortgage debt can typically be seen as an investment as, hopefully, your home will increase in value.

Student Loans: Many people also see their student loan a ‘good debt’ because it is an investment in your education and your future.

Bad Debt:

Now you understand what could be classed as ‘good debt’, it is time to have a look at the darker side of debt in the form of ‘bad debt’. This usually comes hand in hand with spending more than you can afford and living beyond your means. If you plan to keep this buy-now-and-pay-later lifestyle it is a fact that something has got to give, and many people who are struggling with bad debt go on to seek professional debt management help and advice. Bad debt can include:

Credit/Store Cards: It is so easy to get into unmanageable debt with the help of credit cards and store cards. They are generally accepted everywhere and many people use these to purchase items which they cannot afford right away. Before the credit crunch, many people could get a credit card with a reasonably high spending limit, which could spell financial disaster if you are unable to keep your spending in check.

Personal Loans: These differ from secured debts as they are not secured against any asset, usually have a higher rate of interest and are typically used to fund personal spending.