Borrowing & Debt

Debt is a way to use someone else's money (capital) to buy something now, and pay for it later. It’s a way of investing in your future by selling your future assets (e.g. wages) in exchange for present assets (e.g. a house). It is a way to access capital.

Debt is a great way to invest in assets that are needed to generate income (e.g. a vehicle, a computer) or assets that will increase in value over time (e.g, real estate). However, debt becomes a poor financial strategy when we have a short-term need for a non-essential asset and we use debt to purchase it. This is what we call ‘living beyond our means.’ It’s a way of spending today to live well today, but it can leave us with a lot of debt to pay off in the future.

Debt as a Tool

Used well, debt can help us purchase assets that will help us prosper in the long-term. Used poorly, debt can leave us struggling in the short-term, and facing challenges in the long-term. Debt can be good or bad, depending on the context. The trick is to know when to use debt and when to avoid it.

Good debt

A good debt is an asset that will increase in value over time and will be used to generate income. A good debt is a purchase that we can afford to pay back and will be used to help us become wealthier in the long-term.

Here are some examples of good debt:

  • A mortgage on a house you plan to live in, or invest in.
  • A student loan for a college or university education.
  • A loan for a vehicle, computer or other asset that will be used to generate income.

Bad debt

A bad debt is a non-essential spending decision that we cannot afford to pay back in the short term. A bad debt is a purchase that will not increase in value over time, and that we cannot use to generate income. A bad debt is a purchase that is not worth the money (interest) we pay for it.

Here are some examples of bad debt:

  • Credit card debt.
  • An expensive vacation.
  • Any loan that is not helping you generate income.

Interest

Interest is the extra money you pay to use someone else’s money. It is a fee that is charged for borrowing, so when you borrow $100 for example, you are obliged to pay back $110, or $120, or more, depending on the interest rate and how long it takes you to repay the amount you borrowed (the principal).

Interest Rates

The interest rate is the cost of interest expressed as a percentage of the amount that is borrowed. For example, if you borrow $100 and pay back $106, you are paying 6% interest. Interest rates can vary from 1% to 20% or even higher, so you can see that a low interest rate and fast repayment is to your advantage.

Check out our mortgage calculator for an example of how interest rates can affect what you pay on a loan.