Sign up for the latest news and insights
Sign up for the latest news and insights
In quality and in quantity, not all debt was made equal. For a lot of people, a common goal is to be debt-free. However, did you know that there is both ‘Good’ and ‘Bad’ debt? Understanding the difference between these can help you make better financial decisions.
Good Debt helps you purchase assets that help you build wealth, such as assets that provide an income and/or grow in value over time.
Common examples of Good Debt include borrowing money to purchase an investment property that provides rental income or borrowing money to invest in shares or managed funds. Business loans can also help businesses to expand and grow.
These types of debt assist you with building wealth, so are considered good or positive debt. In other words, Good Debt makes you money. In some cases, the interest payments for investment loans can be tax-deductible, providing additional benefits.
Another example that can be considered Good Debt is HECS or HELP loans, as these allow you to borrow money to study a degree/course at a university or a higher education provider. In many cases, these courses can provide greater career options and significantly increase your income-earning potential, and therefore positively assist with building wealth. HECS or HELP debt also has the best repayment terms of any loan, as they are only indexed with inflation rather than interest.
Bad Debt can be detrimental to your wealth if used to purchase assets that will fall in value, will not generate income, and are not tax-deductible. On the other hand, Bad Debt costs you money.
Common examples of Bad Debt are using a credit card or personal loans to purchase goods and holidays. Cars purchased through finance are also Bad Debt because as soon as you drive the car out of the dealership, it drops in value.
Another type of Bad Debt that has increased in popularity is ‘buy now pay later’ services such as Afterpay and ZipPay, as it is easy to spend more than you can afford. While these services might not charge interest, the late fees for not making repayments on time can add up, and this can also negatively impact your credit history.
A mortgage used to purchase the home you live in can be considered both Good and Bad debt, or debt neutral. A mortgage allows you to stop paying rent and gives you somewhere to live which should hopefully increase in value. However, a home loan does not provide an income and can also turn into a bad debt when people overstretch themselves, otherwise known as mortgage stress. Ideally, your mortgage repayments should not consume more than a third of your income. Given the RBA reduced interest rates to 0.10% last Tuesday and interest rates are not expected to rise for three years, now is a great time to maximise mortgage repayments and work towards paying off your home sooner.
While Good Debt can help you build wealth, it is crucial that you use these types of loans correctly. As with all debt, you need to be able to afford the repayments. When managing debts, bad debt should be repaid as a priority, focusing on debts with the highest interest rate first to reduce your interest costs over time.
If you have any further questions regarding Good and Bad Debt, please reach out to connect with us.
Hewison Private Wealth is a Melbourne based independent financial planning firm. Our financial advisers are highly qualified wealth managers and specialise in self managed super funds (SMSF), financial planning, retirement planning advice and investment portfolio management. If you would like to speak to a financial adviser on how you can secure your financial future please contact us 03 8548 4800, email firstname.lastname@example.org or visit www.hewison.com.auPlease note: The advice provided above is general information only and individuals should seek specialised advice from a qualified financial advisor. The views in this blog are those of the individual and may not represent the general opinion of the firm. Please contact Hewison Private Wealth for more information.