Becoming debt-free is something we might all think of as a big step towards financial freedom. Collecting debts throughout your life, like student loans, mortgages and credit cards, can become stressful and overwhelming. But is getting debt-free the answer? Is there such a thing as good debt?

What does debt-free actually mean?

The term “debt-free” actually has two slightly different meanings depending on your approach to managing money. To some, being debt-free means not owing lump sums of money that you pay off month to month. To others, it means not paying for your day-to-day spending using credit facilities. 

The first definition is sometimes called “bad debt”. That is money you’ve borrowed that doesn’t have any long-term financial gain, or is more than you can afford. This could include payday loans or neglected credit card debts. They have a habit of sitting in your finances, leaching your funds through high interest.

The second definition is often known as “good debt”. Borrowing that has a clear long-term financial or personal benefit and has reasonable and affordable repayment terms. This could include a mortgage, a student loan, or a business loan. “Good debt” is borrowing that moves you closer to your financial goals.

So, when we talk about getting debt-free are we really saying that we want to be free of bad debt? Do we live in a world where having no debt at all can be a negative thing in its own right? Let’s look at the pros and cons of going debt-free and whether it’s the right decision for you. 

Going debt-free: The pros & cons

Debt is often seen as a dirty word. But managing debt in the right way can help you achieve financial independence. The key is understanding debt in a way that helps you to grab opportunities and sidestep pitfalls, so you only keep active lines of credit that benefit your goals and ambitions.

The pros

• No more interest: Going debt-free is also going interest-free. Getting rid of possibly the worst part of borrowing. Of course, lenders need to make a profit, but high-interest charges can dent your income when left unchecked over time and can cause a great deal of stress and worry. 
• Better savings potential: losing your monthly debt repayments gives you more money in your pocket. Interest paid on debts is often higher than interest earned on savings, so clearing your debts first boosts your savings potential and gives you extra cash for your financial goals.
• More financial independence: With great savings potential and more disposable income, you’re better placed to build an emergency fund to cover any of life’s curveballs. Grow a safety net savings pot with 3-6 months’ worth of your income for more financial security.

The cons

• Lower credit scores: A great way to show potential lenders that you can be responsible with credit is to, well, be responsible with credit. Being debt-free can mean less activity on your credit history and potentially even hurt your credit score.
• Higher mortgage rates: A major downside of going debt-free negatively impacts your credit score is that you might not get the best deals on things like mortgages. With big loans, better interest rates can save you £1,000s in the long term, so it can pay to keep your credit healthy.
• Fewer financial goals: Some debts are necessary for life progression. A student loan might help you land your dream job, a mortgage could be the only way onto the property ladder. Investment debts can have positive financial and personal gains that you may not be able to afford otherwise.
• Early repayment fees: It’s worth checking that you won’t be charged for early repayment of a debt. This can be true of mortgages. If paying it off early will incur a charge, perhaps hold the money in savings (earning interest) until the fee is smaller or has gone completely.
• No credit card benefits: Going totally debt-free might mean no more credit cards. That’s not all bad, they can make your spending habits less focused and more reckless. Credit cards can also be really useful tools for financial independence, especially when you’re travelling.

Is going debt-free right for you?

If you were to be very strict about it, being debt-free would mean living without good debt or bad debt. That might put more money in your pocket in the immediate sense, but it could also make it harder to strive for financial goals like going to uni or making a life-changing purchase like a house.

So, why not use debt to suit your needs? Prioritise clearing bad debts that don’t offer any long-term benefit and just accrue high interest, but at the same time boost your financial literacy to better understand how debt can help you move forward in life with affordable and manageable repayments. 

If you’re worried that managing debt will negatively impact your credit score, Loqbox uses your monthly rent to build your credit history without having to borrow anything. Connect your bank, tell us when and how much, and we’ll let the credit reference agency, Experian, know.  They add this information to your credit report, helping to show lenders your creditworthiness.