Wooden blocks spelling the word debt

Good Debt or Bad Debt?

No one seeks to take on debt, or do they? The UK Financial Conduct Authority is urging 12m British borrowers to seek help from their local banks. However, contrary to the widely-held belief that debt is a last resort, it is a necessary liability for the majority of our population. From student loans to mortgages, debt is everywhere. 

Loans give you control and, when used properly, can become an asset. As a student, investing in your education using a student loan is widely encouraged. That being said, it is important to manage this debt responsibly. Alternatively, prepare to be one of the 12m Britons seeking support. As many unemployed graduates demonstrate, debt can destroy a future just as well as it can create one.

As an entrepreneur, the foundations of your business lie in investment from angel investors and later financial institutions. Part of these investors might be banks, loaning you an amount of money in exchange for interest. While this might seem daunting, there are advantages to taking on debt: for instance, the amount paid in interest is tax deductible, giving you more capital to invest elsewhere to scale up your business.

That being said, before receiving a loan, the affordability of the interest rate should be considered. To ensure some form of payment, banks use collateral as a form of insurance. One must therefore feel comfortable putting valuable assets at risk. For the younger population, establishing a good credit rating is key to not only receiving the loan, but also obtaining a good interest rate, diminishing the risk involved with borrowing. A credit rating is a way of quantifying how reliable an individual is deemed to be in regards to repaying a loan. The better your credit rating, the lower your interest rate will be. Improving the score can be as simple as obtaining a credit card, storing money on it, and paying bills.

Having obtained the loan, assess how you will meet the regular payments. A business loan might require monthly payments, for which you will need some form of income. Assuming a certain income, managing your spending by ensuring that you can afford the interest payments should be a priority. Many business people also use loans to fund the purchase of assets, thus turning the liability into a source of income. The author of “Rich Dad Poor Dad” demonstrates how, with little input, money can work for itself. Using loans, Robert Kiyosaki bought over 1,600 properties which he rents out, the profit going to funding the interest rate of the debts.

While most young students have no intention of becoming entrepreneurs, the idea of making money work for you is applicable to student loans. When given credit for education, one is essentially taking on debt to gain knowledge. In this way, money acts as a mediator for knowledge, in the hope that in the future, it will be repaid. Young people with student loans should focus on their education to attain the jobs they need to repay the loan in the future.

It is important to not only assess what type of loan you can afford now, but also speculate on how a changing macro-environment might affect your income. With unemployment rates having surged to around 5% as a result of the COVID-19 virus, an increasing number of people have been left unable to reimburse their debts. Unless the situation is resolved, a growing number of young people will become unemployed. Although these threats are merely hypothetical, its important to prepare for the worst. To adequately manage debt, a savings account could help pay the interest in case of a loss of income.

Managing your finances becomes an important factor in minimising the risk involved in borrowing. Having just received their first loan, young people could be tempted to spend the money on nights out or expensive clothes. Although Kolb’s theory states that the development of knowledge is acquired through experiences and making mistakes, experience can be derived from other sources.

A small adjustment to the education system to prepare younger students for what awaits once they leave would limit the growing number of people struggling to repay loans. Many students decide not to attend university, due to the preconception that a student loan is like any other loan. This very misconception illustrates how the education system is failing its students. The change needed could be as simple as incorporating PSHE lectures on how loans can help, along with other key knowledge many students never acquire. This minor but necessary change in the education system would not only inform young people as to what a loan is, but also as to how to use it. 

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