Good Debt Bad Debt Imbalance Is The Cause Of Our Financial Crisis

By: Paul Odunaiya
Introduction

The malaise in our current financial system and in our financial lives can be traced to the significant amount of bad debt we now carry compared to good debt. Even our country’s total national debt is at an unprecedented level. It was estimated at £1340 billion as at March 2008 according to the Centre for Policy Studies. This amount is more frightening when you consider that it is a whopping 103.5 per cent of our GDP. But firstly, we need to understand what bad debt is in all its forms and how it has caused our financial crisis as consumers. And also, what is good debt? Finally, we need to consider what options are available in confronting these problems.
Defining Bad Debt

There are two types of bad debt in this context: bad debt in reference to companies and bad debt in reference to the consumer or individual. Consumer bad debt is debt incurred unnecessarily. For example, buying a £10,000 car on credit when you could afford to buy a cheaper car and avoid credit altogether; buying yourself the 20th pair of designer jeans and shoes when you obviously do not need them. In effect, it is the using of substantial amount of credit to buy unnecessary goods and services. For companies, bad debt is debt that cannot be collected or the debt from a sale that will not be paid. This type of debt is usually written off and most of the time it is an expected cost to be incurred in the normal course of running a business. However, when these bad debts become a significant part of a company’s balance sheet, as we are currently seeing with the banks that are going under, then it is a serious problem. This principle of unnecessary spending can be applied to companies as well. Indiscriminate entertainment spending or housing clients in expensive hotels on credit instead of prudent alternatives is an example of bad debt spending.

Defining Good Debt

With all this talk about bad debt, you may begin to wonder what good debt could be. Good debt is debt incurred for investment purposes or an important need with a clearly thought out plan on when and how to pay it back. Examples are mortgage debt, debt incurred for home improvements, debts incurred to advertise a product or a service. The reason that mortgage debt is a good example is because it’s a form of investment where a lot of work is usually done to assess a borrower’s ability to pay back their loan. Note my use of “where a lot of work is usually done”. One of the main reasons for the current financial crisis faced by banks is because the review and quality control carried out before offers are made have been very poor in recent years. A form of debt that we would classify as a good debt has been turning bad with high frequency. Therefore, the supposedly good debt was not good when it was set up in the first place because of the poor quality of assessment. This is not to say that a good debt cannot turn bad but based on historical analysis of this type of debt only a low percentage goes bad. Of course there is always the unforeseen problem that may arise and which may affect people’s financial circumstance which can also turn a good debt into bad debt.

The culprits

So who is to blame for our bad debt problems? I’m afraid it’s everyone. The banks for being lax in their lending procedures, companies and individuals for spending wastefully on credit, the government and policy makers for encouraging the ‘buy now pay later’ culture and the education system for failing to prepare us for this credit driven capitalism system.

Solutions

By now you are beginning to ask, what are the immediate solutions available to deal with these bad debts? While there needs to be a more comprehensive solution from all stakeholders, it will take a number of years to resolve a deep-rooted problem. The good news is that there are a number of solutions available to companies and individuals. However, the first step is to look into your current state of financial affairs with the help of a professional. It is from this analysis that a professional debt advisor will be able to determine the appropriate solution for you. The solutions range from Debt Management Plans, business rescue packages, Individual Voluntary Arrangements to bankruptcies as a final solution. You can also find websites with videos and online financial calculators that can help guide you on what to do. Having a bad debt problem is not the end of the world, but dealing with it in time allows us to start afresh so that we can reverse the imbalance of bad debt to good debt.
Paul Odunaiya is an insolvency specialist and the managing director of Qsolvency LTD, which trades as online-debt-advice.co.uk Paul has over 5 years’ experience in helping individuals and businesses in financial difficulties navigate their way out of serious debt.