September 17, 2019 Demystifying debt – bad vs good!
The word ‘debt’ cops a bad wrap, in my opinion.
Mention debt, and our minds tend to jump to the negative connotations of the word. And rightfully so.
‘Bad’ debt is exactly that – not great.
Meaning, any debt that’s not going to make you money over the medium to long term (aka building your wealth) is something you want to avoid like the plague.
Well, as much as you can. The problem is this: you’re effectively robbing your future self to spend what you can’t afford today.
For most Australians, debt’s become a way of life. Last year, the total amount of credit card debt Australians owed was $45 billion.
Let that sink in for a second. That’s huge! In fact, to say that most of us are leveraged to the eyeballs is an understatement.
Let’s have a look at good versus bad – and I’m talking the typical ones. I’ll start with the latter…
Here’s my take. If you’re using your credit card for essential purchases and you intend to pay off the total amount within the interest-free period, cool.
No worries. That’s smart. For non-essential purchases where you don’t have the discipline to pay off that amount within that period, though, that’s not so cool.
Particularly when interest rates are sitting between 12 percent to 30 percent. If you have credit card debt, making only minimum payments on a high-rate card is just crazy.
One of the biggest emotionally driven purchases you can make (property aside, obviously) from my experience is buying a new car.
There’s something about being in the showroom – and that new car smell that takes over.
Taking on debt for a car that’s going to depreciate significantly over the next five years is insane when you think about.
Unless you’re gaining some kind of tax advantage, I think borrowing to buy a brand-new or near-new car is generally a bad idea.
A mortgage, on the other hand, typically sits at the top of the ‘good debt’ pile. And for good reason, particularly if it’s helping you build your wealth over the long term.
A home loan’s good on a number of levels. Interest rates tend to be much lower. If you’re renting the property out, the interest is tax-deductible, same goes with property-related expenses.
If your investment is long term and your home increases in value over time, the gain is often enough to cancel out the interest you’ve paid along the way – a win-win, in other words.
Home equity loans
If you already have a mortgage and you’ve got the best home deal you can get – if you don’t give us a shout! – chances are you won’t get debt much cheaper than borrowing back against your home.
With personal loan interest rates sitting around the 12-13 percent mark, financing, say, a new car through your home’s equity is significantly cheaper when you weigh up how low home loan interest rates are at the moment.
Car finance (business)
Now, this only applies if you run your own business.
A friend of mine recently got a super competitive chattel mortgage, took advantage of the small business asset depreciation write-off and saved $13K in tax when he purchased a $30K car, effectively meaning the car only ended up costing him $17K through his business.
Plus he gets to claim the interest along the way.
Back to my point earlier, if you’re considering refinancing your mortgage and you’d like to know whether you’re getting the best deal you can, give me a shout.
You’d be surprised just how much you can save each year, even if it seems the most marginal of drop in interest rate. Better in your pocket than the bank’s, if you ask me.