Everyone would prefer to be debt free, but borrowing money isn’t always negative. Do you know the difference between good and bad debt?
Debt is a word that often has negative connotations. Many people are embarrassed about owing money, and allowing debt to accumulate can cause a significant amount of anxiety.
The Australian Psychological Society’s Stress and Wellness Report 2011-2015 revealed that personal financial issues were the leading cause of stress in the country for five consecutive years.
But is debt always bad? Or is it possible to adjust our approach to borrowing and turn a potential negative into a positive?
The Australian Securities and Investments Commission estimates the nation owes approximately $32 billion of credit card debt.
Professional financial advisers can help you manage your money more effectively, but for now, let’s examine some examples of ‘helpful’ versus ‘hindering’ debt.
Helpful debt may sound like an oxymoron, but there are plenty of ways borrowing can help you prepare for the future.
Educational debt: Whether it’s higher education, an apprenticeship or other education and training courses, learning the skills and qualifications you need to further your career comes at a cost. But this is an excellent opportunity to invest in a potentially lucrative asset – you!
Mortgages: The latest CoreLogic data shows the median property price across Australia’s combined capital cities is over $625,000. Most people don’t have access to this kind of cash up front, but obtaining a mortgage enables you to buy into a tangible asset that can increase in value over time. If it is your home, the debt will not be deductable (bad debt) but hey, you will have a place to live and there will more than likely be capital appreciation over time.
Investment loans: whether it is for an investment property, share portfolio or other income generating asset, the positive side of investment debt is that the interest is deductable from your total taxable income for the year. It also means you are able to gain more exposure to income or capital growth than you would be able to access via cash only.
Business loans: Many people dream of running their own business, as it can provide work-life flexibility, a chance to grow wealth and a sense of personal fulfilment. Set-up costs can be considerable, however, and many start-ups don’t turn a profit in their first year, so you’ll likely need to borrow money to get the ball rolling.
‘Helpful’ debts can be considered investments into your future, but what about the flip side of the coin?
Credit cards: The Australian Securities and Investments Commission estimates the nation owes approximately $32 billion of credit card debt. The rates on credit cards are often higher than traditional loans and consumers can quickly find themselves paying off little of the underlying debt because they’re struggling to cover interest charges.
ASIC Media Release: Clock is ticking on credit card debt http://t.co/uLZBTRbG
— ASIC Media (@asicmedia) March 5, 2012
Depreciating asset debt: New cars, consumer technologies and big-ticket appliances are just some of the items that people incur debt to buy, but almost all will lose value over time. If possible, save for these purchases rather than use loans or other forms of borrowing.
These types of debts may allow you to have what you want now, but if not dealt with quickly, can be a drain on your cashflow overtime.
Bear in mind that even ‘bad’ debt can have positive results; keeping on top of your payments should give you a better credit rating over time.
As such, building a good credit rating via small loans, payment arrangements and clearing credit cards will show lenders you are reliable when it comes to larger borrowing needs, such as mortgages.
Just because you have debt, doesn’t mean you are in a bad place financially. It is the type of debt, how you are using it, and how you are repaying it that matters. Interest rates, loan products and legislation change constantly. The great new is that even if you are in a ‘bad’ place now with debt, there are often relatively clear and easy ways to transition back on track. You don’t have to negotiate the world of debt alone.
Download our free introductory guide to debt recycling
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