Why are home loans responsible borrowing?
Debt can be scary and confusing, especially if you’re new to the world of finances. One of the things you may have heard of is good debt and bad debt. Good debt is borrowing for a specific purpose that is essential to you and your financial growth, whereas bad debt is debt that doesn’t contribute to your overall financial wellbeing such as store and clothing accounts.
That doesn’t mean that you shouldn’t have any of the bad debt as these are the types of borrowing tools that will help with your credit score that will be factored into consideration when you apply for good debt.
There are pros and cons to both good and bad debt – it all depends on the purpose and how you use it. You may think that a clothing account is bad debt and that you should only borrow for bigger buys such as homes and cars, however if you’re starting your financial journey and don’t yet have any debt, a clothing account will help you build a credit score so that you can eventually apply for a home or car loan.
So where do you draw the line and how do you make the right decisions? It’s important to first understand the basics. Here’s what you need to know.
Why should we have debt?
Although debt comes with a certain stigma, not all debt is bad and you should strive to find that balance in your finances. It all depends on how you use the debt and how you manage it. If used right, debt can help you achieve your financial goals and grow your wealth and simultaneously help you to build a good credit profile.
You should have debt to build a good credit profile because without a credit profile you won’t easily be able to apply for a home or a car loan. You need to have debt to show that you are responsible and can manage it. That is why it’s important to carefully choose your debt based on your needs and what you can afford.
Debt shouldn’t be a death sentence. If you make the right choices and manage your debt well by paying in full and on time it will help you to borrow for the bigger things when you need to.
Good vs bad debt
Whether debt is good or bad depends on what you use it for. Yes, there are certain types of debt that are considered unnecessary such as clothing and store accounts and others that are clearly for your financial wellness such as home or car loans. What you need to keep in mind is what you use it for, how you use it and the impact it has on your credit score. You may need to open a clothing account to kick-start your credit, but if you constantly max it out to buy clothing when you don’t really need it, it’s bad debt that can hurt your credit score and diverts money from more important borrowing tools.
If you find yourself relying on debt to survive month-to-month you’re in bad debt territory and will need to find measures to fix this to improve your credit score. Some debts are neutral where making debt to afford something is unavoidable. That would be like a store account to buy appliances such as fridges or washing machines. We don’t all have the cash to fork out if you need a new one, so taking on debt for this would be a good solution. What you need to be careful of is misusing this debt to buy things that you don’t need. Rather take on the debt for what is necessary and pay it off within the agreed period.
Debt really becomes bad debt when you are spending more than you can afford. Having a clothing account for emergencies doesn’t necessarily mean that you have bad debt, but if you are only paying the minimum repayment amount and keep buying on the account it becomes negative spend that you cannot afford. Good debt is borrowing in such a way that there is financial gain in it for you, such as home loans which will have a return in investment.
Maintaining a healthy relationship with debt is important to ensure that you borrow responsibly and according to what you can afford. Yes, emergencies might call for drastic measures, but do your homework first – check the interest rate and the term and determine if you can really afford this clothing or store account.
Examples of good debt:
- Home loans
- Student loans
- Business loans
- Car loans
Examples of bad debt:
- Store and clothing accounts
- Personal loans to support monthly expenses or to fund a holiday
- Credit cards to buy monthly necessities
- Overdraft to make up for cash shortfalls
Types of loans and how to use them
There are six types of loans. Each have different purposes and depending on that you can make the right decision with the right solution for your financial situation.
- Overdrafts – this is a credit facility on your current account to help manage cashflow for emergencies. It is a buffer to avoid penalties if a debit order goes off on the wrong date or if you have a financial emergency. If you have an overdraft on your account make sure that you budget only according to what you earn. If you use the overdraft for things other than emergencies it would become difficult to manage and pay off.
- Credit cards – these are revolving loan facilities where you have access to interest-free credit for up to 55 days. That means that if you use your credit card and pay back the balance you used within 55 days you won’t pay interest and will only pay for what you used. Just like with an overdraft if you spend more than you can afford it becomes bad debt that is difficult to manage.
- Personal loans – this is a lump sum of money paid into your account with a fixed interest rate. This is a better solution for unexpected emergencies such as your fridge breaking. You will have an agreed-on repayment amount that will go off on your current account as a monthly debit order which means that you won’t forget to make a payment.
- Student loans – these are loans for studies, to help students pay for books, tuition, living expenses, etc.
- Car loans – these are to buy new or used vehicles. You can also get a personal loan to buy older cars if you can’t afford a newer model.
- Home loans – this is to buy property or to invest in developing new properties. This is a form of good debt as it is an investment that you will eventually get return on.
Why you should get a home loan
A home loan is a form of good debt. It is a long-term investment to grow your wealth and what you put in now will earn interest for when you want to sell one day, or if you plan on renting out the property, you can use the rent money you get to pay off your bond.
How it’s structured:
- Ordinary home loan is typically structured over 20 years, but longer or shorter periods are available.
- A deposit may be required, but 100% loans are available, depending on the value of the property.
- The interest rate can be fixed or variable.
- Fixed monthly instalments (but adjusted for changes in interest rates if you choose a variable interest rate).
- Can be registered as a joint bond, with two or more parties responsible for the repayment.
What are the costs that you need to keep in mind?
- A once-off Initiation fee and monthly service fees apply.
- Other non-finance fees apply (for instance bond registration and lawyer fees when registering your bond).
- Bond cancellation lawyer fees for cancelling your bond after you have paid off your home loan and want your title deed or when you are selling your home.
Home-Buying Toolkit
Use the home-buying toolkit to:
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