Good Debt, Bad Debt, and your Credit Score!
How does Credit Work?
Credit is a tool that can help you pay for big ticket items to meet your financial goals. Credit can follow you though, so it must be used wisely!
When Does Credit Come into Play?
Whether you are applying for a credit card or buying a house, your credit will play a large role is these transactions. Your credit is somewhat like your reputation, and it is taken into consideration by lenders prior to giving you access to their resources (i.e. prior to loaning you money). Credit scores can be considered in a number of situations including, but not limited to:
- Registering for a cellphone plan
- Applying for a credit card
- Purchasing something with financing (e.g. paying for a TV over 12 monthly payments)
- Buying a car
- Renting an apartment
- Applying for a mortgage,
- And more!
As mentioned above, credit acts as your reputation, or your "worthiness" to be lent money. In order to quantify your "worthiness", a credit score is calculated for you, and this is what business use to determine whether they can lend to you (and potentially what your lending rate might be). In some cases, with poor credit, you may pay higher interest, due to your lack of "reputation" or "worthiness", as those businesses must take a bigger risk in lending you money.
In general, a credit score is a number between 300 - 900, with credit scores between 660 - 900 being considered good to excellent.
Debt: The Difference Between Good & Bad Debt
Good Debt is an investment in something that creates value or produces more wealth in the long run. For example, putting your money into a GIC will lock up your money in the short term, but you have the opportunity to gain interest at the maturity of the GIC. Another example could be buying a house, improving it by renovating it yourself, and then selling it for more than the cost of the house and renovations together!
Bad Debt is taken on to buy something that immediately goes down in value, or something that you can't repay on time and in full, thus accruing interest charges and hence more debt. For example, purchasing a 60" TV because you just really want it, but can't afford it, is an example of bad debt. If you can't make the payments over the 12 months, you simply accrue more interest and go further into debt, while the TV cannot be returned for it's original value, and only more money can solve the growing debt.
How Much Debt is Too Much?
According to Statistics Canada, the average Canadian university graduate finishes school with more than $26,000 in student debt.
For a student with $26,000 in student debt, the average repayment is approximately 114 months, or 9.5 years. This is with an interest rate of 6%, and monthly payments of $338.
Best Practices for Managing Debt
Going into debt may be required to attain some of your short term goals, and that's okay! There are supports and services designed to allow for this. Although you may need to go into debt, we encourage you to consider the tips below in order to keep your debt under control:
- Always pay on time
- Take on as little "bad debt" as possible
- Pay more than the minimum payment that is due
- Make extra payments when possible to reduce your outstanding balance
- Consider connecting with your lender to see if you can negotiate a better interest rate
- Live within your means
- Don't spend money you don't have