Time to read : 5 Minutes
Should you ever get into debt? Most of us would instinctively say no. But debt is like any other financial tool.
It’s neither good nor bad because it depends how it’s used – or ‘leveraged’ as the finance gurus say. It’s definitely possible to use good debt sensibly.
Did you say ‘good debt’?
I did – good debt is absolutely a thing. So consider this Gillian’s good debt guide.
Before I go any further, a quick note: debt can spiral so it’s wise to consult a financial professional before making any big decisions. Everything below is a general overview of how debt works and how you may be able to make debt work for you.
So what exactly is ‘good debt’?
A financial expert I once worked with said it boils down to this:
Does this debt feed you and your family? Good.
Are you feeding the debt (without it feeding you/your family)? Bad.
You’ll easily see that most forms of debt do a little of both – but what you’re after is more of the ones that feed you – and less of the ones that don’t.
Usually, good debt is also secured debt. This means your debt is backed by a real life asset that holds (or increases) in value over time – like your house or apartment.
A mortgage is the most common example of ‘good debt’ because your home:
Shelters you adding a real benefit to you and your family.
Usually holds its value over the life of your loan.
Is likely to increase in value over time while your debt decreases.
You’re also able to add value to your home with renovations and improvements: this can sometimes be drawn from your current mortgage.
Your home is considered an “appreciating asset”. That means it’s expected to be worth more than the debt it carries.
This is why home loan interest rates are usually lower than any other type of credit product like credit cards or personal loans.
This isn’t the case with a car loan, because cars usually decrease in value over time.
So does that mean car loans are bad, right?
Not necessarily. Again, it depends how you manage this debt, and why you want or need your car.
A car loan is really a type of personal loan, with high interest rates and shorter loan lengths. Your car loan can be good debt if it’s for a reliable vehicle you really need.
If you score a new job with a car as a requirement, then getting one makes sense – though there’s a difference between borrowing to afford a runabout, and borrowing so you can drive a cybertruck.
Look for vehicle makes and models that hold their value well. Shortening your loan term can also minimise the total interest paid, though your car repayments may be higher. It’s also possible to consolidate your car loan with your home loan.
Note: this is an important conversation to have with your mortgage broker before applying for a home loan.
Top tip: research car loans before you go into a dealership. Dealer loans can have quite high interest rates. Ideally, you want the lowest possible rate over the shortest period of time.
Is HECS/HELP debt good or bad?
Education debts should be good debts because investing in your education is supposed to pay off later on with better, high earning employment prospects – right?
It’s true that most people with higher qualifications are more likely to work in higher paying jobs. Lately though, these debts are weighing down the financial progress of graduates who might otherwise look to buy homes and start families.
Watch this space though, because legislative change is impacting this type of debt.
If you’re looking to make a home purchase in the next few years, reducing this debt as much as you can will make a difference to your borrowing capacity.
Are personal loans definitely bad debt?
Personal loans can be bad debt depending on the purpose of your loan. Taking out a personal loan to invest in, or expand, your family business may be a good example of debt if it helps you make more money in the long term.
It’s not a great idea to use it for non-essential expenses like a wedding or a family vacation. That's getting into bad debt territory.
That said, personal loans typically offer lower interest rates compared to credit cards. If you're considering a personal loan, talk to your bank about options for refinancing or debt consolidation.
Are credit cards and payday loans bad?
Bad debt can be characterised by loans with:
high interest rates
burdensome repayment arrangements
crippling late fees
terms and conditions designed to keep you in day-to-day debt.
Payday loans are notorious for their high interest rates and hidden costs, making them difficult to repay quickly. Many of these types of credit arrangements are considered predatory by the regulator.
Important note: Buy Now Pay Later (BNPL) providers are currently under scrutiny for some of these practices too.
High-interest rate credit cards can also become bad debts for you if you’re not managing them properly. It's easy to overspend and end up paying hundreds in unnecessary interest.
Tips for managing credit card debt:
Use your interest-free period wisely. This means paying down the amount you owe as much as you can in that timeframe.
Keep track of your spending – it requires you to be vigilant, but it’s worth it.
If you're struggling with your repayments, you may want to consider credit cards with lower interest rates and fees, or look into interest-free balance transfer options.
Bottom line
Managing debt effectively is all about understanding your finances and making informed decisions.
Before agreeing to take on any form of debt, check it aligns with your financial goals and is manageable.
There are alternatives to predatory loan contracts, like refinancing, debt consolidation, or No Interest Loan Scheme (NILS) providers.
Speak to your mortgage broker or financial counsellor to help you stay on track.
If you’re interested in consolidating your loans to help reduce fees and additional debts, reach out to the experts at Compare Club.
Go deeper:
Dissecting the budget – does the cost of living relief go far enough?
What does a lender look at in a basic home loan application?
Financial Disclaimer
The information contained on this web page is of general nature only and has been prepared without taking into consideration your objectives, needs and financial situation. You should check with a financial professional before making any decisions. Any opinions expressed within an article are those of the author and do not specifically reflect the views of Compare Club Australia Pty Ltd.
