Why not all debts are the same

    People are often told that to manage their money effectively they should do things such as “look after the pennies” or that they should follow the Micawber Principle and ensure that they never spend more than they earn. However, if you want to be truly financially literate, you need to understand more than just how to manage your cash flow – you need to understand debt.

    The last few years of the global financial crisis have made everybody wary of debt – Greece can’t pay for the debt it has, students are being put off going to university by the thought of incurring debts of over £30,000 – but not all debt is the same and not all debt is bad. For example, if we want to buy our own home, most of us will need to get a mortgage that will we repay over a period of many years, at a relatively low rate of interest compared to other forms of debt.

    Because most of us will need to save for a deposit before applying for a mortgage, it isn’t a debt that you rush into, yet the problem for many people who get into financial trouble is that they haven’t planned for it. Many people get into debt because they are already struggling to make ends meet and an unexpected cost, such as the boiler breaking down, leaves them with insufficient money to pay their bills.

    Payday loans are becoming increasingly common among vulnerable people who find themselves in just this position and a Which? survey earlier this year showed that 60% of people taking out these loans are using them to pay for household bills or other essentials. Even more worrying is more recent research from Which? that claims that almost half of people taking out payday loans cannot afford to repay them (and a third of them are taking out loans knowing that they will not be able to repay).

    The most obvious concern for anyone using a payday loan is the incredibly high rate of interest and the charges incurred for defaulting on repayments but there are other reasons why you should avoid this type of debt, particularly if you are one of the growing number of students using these services.

    Many banks and mortgage lenders are now treating payday loans differently from other debt when they consider your credit rating. Using a payday loan is being considered as a sign that you are not managing your finances effectively, so you won’t be successful if you try to apply for other loans in future.

    For the student who graduates having used a payday loan service at university, they could face significant problems when they need a loan to buy a car or are seeking a mortgage for their first home – an unpleasant reminder that not all debt is the same.

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