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Debt, good, bad and ugly

Girl managing debt and bills

Debt isn’t an attractive topic, but Australia is a nation plagued by it. In fact, Aussie household debt levels are some of the highest in the developed world, sitting at 105 per cent of GDP, according to the Debt and deleveraging report1 released last year by the McKinsey Global Institute.

In people terms, Veda’s Australian Debt2 survey highlights that 55 per cent of Australians aren’t comfortable that their current debt level is within their budget. It goes on to reveal that one in five Aussies admit they are struggling to repay their current credit commitments, just over a third receive assistance from family and friends, and a quarter have resorted to selling assets.

However, debt isn’t all grim news. There’s good, bad and downright ugly debt. The goal is to carry the right kind and not too much of it. But how do you know what you should and shouldn’t risk your finances for?

Good debt

Good debt helps you to achieve a positive result within a specific time frame, such as building assets and gradually increasing your net worth.

Mortgage debt is obviously a good thing. It allows you to purchase a home or investment property that will very likely appreciate in total value over time. If the property is for investment, it is an asset capable of bringing in extra money from the rental market.

The bonuses don’t end there. A mortgage is tax-deductable, and there’s also the benefit of safeguarding yourself against inflation. While inflation can chip into other investments, it can’t affect a locked-in interest rate for 25 years.

Education is another type of good debt to carry, since school fees and tertiary education is seen as an investment that can maximise your future earnings.

Bad debt

Bad debt covers a lot of areas, but it usually describes short-term debt, where the loan lasts longer than the item you bought or there’s no financial return. It can also be money you borrowed at an unreasonable interest rate, or in instances where your interest isn’t tax deductible.

Buying a car that’s well out of your budget is bad debt, as is agreeing to a long-term car loan you’re paying high interest on your new vehicle while the re-sell value drops. The same goes for a boat or holiday house that you don’t use enough.

Surprisingly, mortgages can enter bad debt territory as well. Paying just one per cent or higher in interest rates that you can now get cheaper can hurt your finances in the same way that borrowing a higher debt-to-equity ratio (borrowing more than 85 per cent of the purchase price) can. This tends to be short-term debt in which the loan lasts longer than the item you bought with the debt

Ugly debt

Credit card debt makes up the majority of this category. Some Aussies fall into mounting debt due to financially over committing themselves, while others fail to budget or simply can’t curb their bad spending habits. Splurging on lengthy holidays, buying fancy properties above your means and putting too many expensive purchases on the plastic are all sure-fire ways to enter hefty credit card debt.

Last year, the Reserve Bank found that Australia’s credit card debt was $48.6 billion, the highest on record. And in Veda’s most recent debt study3, it found that 21 per cent of Aussies are struggling to pay their current credit commitments. Despite this, an alarming 25 per cent will apply for even more credit to help them cope during an economic downturn.

Debt has the potential to be a good thing. Consult with a professional first so you can have peace of mind knowing you can afford your debt and that your hard-earned money will reap a winnable payoff.

1Mckinsey Research

2Veda

3Veda. news article 2