It’s doubtful you’ll get through life without some form of debt, especially with big ticket items like buying a house. In fact, it’s really easy to accumulate debt (and possibly stress) along the way – especially with the impacts of COVID-19.
This begs the question, is all debt bad or is there such a thing as good debt? In reality, we can and do classify debt according to whether it is good and bad.
What is good debt vs bad debt?
Generally speaking, good debt is something that increases your net worth over time. In other words, a positive investment that helps you live better or make money.
Bad debt is that which reduces your net worth over time or costs you money.
What are some examples of good debt?
Examples of good debt include study loans such as HELP or HECS debts, business loans or investments and mortgages, which all represent an investment in yourself or your future.
Study loans (HELP or HECS debt)
In Australia, most tertiary education attracts government support through zero interest study loans. Payment is based on your income once you’ve completed your studies rather than a fixed monthly repayment. Study loans generally lead to higher education which is associated with improved career prospects and increased earnings. There is also the added benefit that repayments are interest free. As a result, study loans are in the good list.
- Business loans/investmentBusiness loans can help you set-up your business or expand and grow. In these instances, you’re borrowing money to make money – that means it’s good debt. However, there’s a caveat – are you borrowing money to keep a sinking business afloat. In this situation, it’s important to assess whether you’ll be able to save the business because an investment in a failing business is considered bad.
Mortgage and real estate
In general, a home loan is considered good debt. But it depends largely on your financial circumstances – particularly your good debt to equity ratio and the interest rate on your loan. Mortgages usually have the lowest interest rates of any loan so paying it off early might not be in your best interests, However, if you’re spending more than 40% of your income on your home loan, you will start to live outside your means. This takes your home loan from the good list to the bad.
What are some examples of bad debt?
Bad debt is traditionally associated with purchasing consumables and products that decrease in value or have no monetary value once purchased, for example, car loans and unpaid credit cards.
While a car is often necessary, it starts to lose money as soon as it leaves the showroom. Over time, the value of your car will continue to decrease. It also costs money to service, insure and maintain.
Unpaid Credit Cards
While the use of cash during COVID has decreased for health reasons, using credit cards as a source of money can be expensive. This is particularly true if you use them to purchase things you can’t afford. Credit cards often come with an interest-free period followed by relatively high interest rates. These interest rates have the potential to get you into serious debt.
Unless they’re being used for debt consolidation, personal loans are seen as bad debt. Why? Because personal loans are usually taken out to cover the cost of things you don’t have money for, and while they don’t attract as high an interest rate as credit cards, the interest repayments are still an expense.
Clothing and consumables (Afterpay and similar services)
The introduction of services such as Afterpay and Zip Pay has increased the chances of getting into bad debt. These services allow you to buy now and pay later. They encourage bad financial habits and also attract an interest rate if not paid off on time.
Making sound financial decisions
Understanding your financial situation so you can support your life goals is one thing, but ensuring your money works hard for you is another. At Treysta, we’re here to educate and protect you from making investment decisions that could hamper your financial position or result in significant losses
Disclaimer: any information we share is general in nature and does not consider your personal situation. You should consider if the information is appropriate for your needs and, where appropriate, seek professional advice.