What is good debt? What’s bad debt? Which ones do you have?

There are so many ways to rack up debt that sometimes we don’t even think about it anymore. Student loans, mortgages, car loans, credit cards… which ones are good and which are bad?

Essentially, bad debt costs you money and good debt makes you money.

Let us explain:

 

Good Debts

Student Loans (HELP/HECS)

Why are they good?

Student loans are an investment in your future, opening up different career pathways and the potential to earn much more than you otherwise would.

Another reason HELP/HECS debts aren’t bad is because they’re interest free, and based off your ability to repay them. You don’t have to repay anything until you’re earning over a certain threshold.

 

Business Loans or Investment Loans

Why are they good?

Essentially with business or investment loans, you’re using money to make money.

Generally people use investment loans for property investment, and it’s a common way to build wealth in Australia.

Business loans can help profitable businesses build and grow, provided they have a good plan in place for using the funds.

Consider:

Method matters.

If your business is failing, there’s only so much you can be lent before the banks will stop and you’ll go bust. This is the last thing business owners want. If you’re getting loans because business is struggling, make sure you have strategies in place to improve your business and ensure you’ll be able to make repayments.

 

Medium Debts

Mortgage (Home Loan)

Why are they medium?

Home loans are somewhat neutral debt: they don’t make you money, but they do provide valuable assets and help you build something of value. With a mortgage, you’re able to buy a house, stop renting and have somewhere for when you hit retirement.

Home loans are also generally cheaper than other loans, current rates can be less than 2 per cent (depending on the lender and what you’re after).

Unfortunately it’s incredibly rare to be able to buy a home outright in Australia, thus home loans are a ‘necessary evil’.

Consider:

It’s all about affordability.

Mortgage payments shouldn’t be more than a third of your income (just like rent). Mortgages can become bad debt when people overreach and take on loans they can’t really afford. Make sure you consider the full costs of the house (rates, insurance, repairs, bills) before signing off on a loan that you might not be able to truly afford.

 

Car Loans

Why are they medium?

Car loans aren’t good, but they’re not too bad in some circumstances.

Car loans can be bad when they encourage overconsumption. Many people use them as a way to bounce from car to car, upgrading every few years to keep the flashiest new product. Considering cars depreciate the moment you first drive them out of the dealership, it’s not great to be constantly paying interest on them.

Consider:

Upfront payments.

You might need a car for work and be unable to purchase one outright: in this case, a loan is a necessity. In general, it’s a good idea to pay as much upfront as possible so you have a lower loan and less interest.

Keep in mind too, if you use to car for work or business, you might be able to claim some tax deductions.

 

Bad Debts

Personal Loans

Why are they bad?

Other than very specific circumstances, personal loans are a bad idea. Interest can be around 10 per cent, and for many people it’s a sign that they have spending problems.

Generally, people will take on loans such as this to refinance bad credit card debts as a ‘get out of jail free’ card. Often, they’re also used for home renovations or holidays, not necessarily ‘essentials’ so they can encourage bad spending habits.

People can lose their jobs, be diagnosed with serious illness, or lose a breadwinner and need to take out a personal loan to afford their living costs. If you’re concerned about being able to afford lifestyle costs in this situation, consider looking into some form of insurance. This can be a better solution than relying on personal loans if you are out of income.

 

Credit Cards

Why are they bad?

Credit cards are the worst debt: if you don’t pay them off within the interest free period, you could be looking at an interest rate as high as 20 per cent. This is the highest rate of all the loans listed, and worse than that, credit cards can create dangerous spending habits.

Many people take on credit cards and end up getting into the habit of spending money they don’t have. The perks that are offered to entice people in generally aren’t worth what you’ll spend in the long run.

Consider:

To stay on-top of credit card debt, you should only use them as a means of transaction, never as a source of money. If you’re diligent and pay your full balance every month, you’ll avoid paying interest and may benefit from some of the special points and rewards offered.

 

Need advice for getting on-top of your debts? Want help getting rid of your bad debts and making sure the medium ones are doing more good than harm? We have experienced financial advisers who can help you get back on track with your finances. Contact us and arrange an obligation-free chat!

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