25 Feb 2015
With Australian credit card and personal loan debt standing at $101.4 billion as of December 2014i, it’s time to consider what is good versus bad debt.
Debt is considered good when it’s efficient, that is – it’s working to help you build wealth. Bad debt is categorised as inefficient, because it generally costs money (interest charges) without helping to build long-term wealth.
The good, the bad and the ugly
Good debt is when you borrow to invest and your investment produces more income than the cost of the borrowing. It’s also good debt if, despite the borrowing costs, the investment is likely to increase in value after you have invested, like property or shares. An education loan is also generally considered to be good debt, as it should enhance your career prospects.
Good debt is often used to help build long-term wealth and makes financial sense: you’re better off with it than without it.
Bad debt happens when you borrow to invest but the value of the investment declines over time, or if you borrow to fund your lifestyle. Bad debts include things like a car loan or borrowing money to pay for an overseas holiday.
It isn’t always possible to avoid bad debt, but it’s worth trying to minimise it. For example, if at all possible, avoid credit card debt that can easily spiral out of control with high interest rates.
Making debt work for you
When it comes to making the most of good debt, a debt recycling strategy has the potential to help. Debt recycling can be a high risk strategy – it doesn’t suit everyone – that allows you to use good debt to repay bad or inefficient debt more quickly.
Good debt still presents risks and can be used to buy assets that have the potential to grow in value and generate an income, potentially benefitting you with:
- income to help repay bad debt (and the loan used to fund the good debt); or
- tax-deductible interest charges.
Know your debt options
Whether it’s a mortgage on the family home, a loan for the new car or school fees, the trick to managing your debt is to make sure you use it sensibly.
Here are a few steps to help you get on top of what you owe:
- clarify which debts are good debts and bad debts;
- understand your current financial position;
- consider the terms of any loans (e.g. which are more important, expensive and flexible);
- take steps to reduce your debt;
- minimise financial risk and protect yourself against the unexpected; and
- review your situation.
Whether you want to get on top of your debt, prioritise or consolidate your debt, your Financial Adviser can go through the above steps with you and help you identify what’s best to achieve your personal financial goals.
If you would like to meet with your PSK Adviser, please call us on 02 9324 8888 or click here.
Article adapted from: