Good Debt and Bad Debt
Whilst living debt free seems ideal, it is not necessarily the smartest choice to make regarding your finances. On the surface this may seem rhetorical, after all, as financial advisors and wealth managers we are often stressing the importance of budgeting and building wealth, not ending up ‘in the red’. But once we explain the notions and financial effects of good debt and bad debt, you will understand that some debts can be considered strategic, and not so bad in the long run – as long as your comprehensive financial plan commits to timely repayments.
In general terms, debt is considered good when it is deemed efficient. In this context, efficient debt is debt that is working to grow value or long-term income, the same properties of an effective investment. To simplify, good debt is good because you are better off with it. Student loans – such as the HECS/HELP scheme – is an example of good debt. Not only is the interest charge minimal (usually indexed to inflation rates), but undertaking tertiary education increases your value in the workforce due to the skills and knowledge attained, and raises your potential future income. All other factors remaining constant, a student loan to pay for tertiary education will improve your long-term income capacity, providing the key return on investment that characterises good debt. Mortgages for home loans are also generally considered to be good debt, with the market price of your house expected to rise over time.
As expected, the inverse applies for bad debt, which is generally considered inefficient as it does not directly contribute to building long-term wealth. Bad debt is characterised by additional costs, such as interest repayments, ultimately burdening your financial position rather than building it in the long-term. A car loan is a common example of a bad debt. Not only are you paying interest on your repayments, often charged at a higher rate than many other loans, but the value of your vehicle ultimately depreciates, reducing the value of your assets and long-term wealth. Credit cards are another example of bad debt, which should be always be avoided.
One thing to keep in mind is the terms and repayment conditions for any loan or debt you take out, and the implications they can have on your financial sustainability. Liaising with one of our expert mortgage brokers can ensure the loan you take out is right for you, with repayment conditions optimal given you current and projected financial position, and impact upon other factors such as your credit rating.
If you are looking to take out a mortgage for a home loan, or current debts are proving financial burdens for you, then do not hesitate to get in contact with one of our specialised areas. After all, you should always be seeking to settle debts, rather than letting debts settle.