How to use debt | Why it’s not all bad

How to use debt orange wealth

July 13, 2017 How to use debt | Why it’s not all bad


It’s an often misunderstood term.

For your average Australian, it’s typically perceived as a dirty word, conjuring up a degree of anxiety in the process.

When it comes to the D-word, Australia is one of the most leveraged countries in the world.

With average household debt sitting at around 189 per cent of annual household income, it’s a bit of a worry.

A lot of that has been spurred by historically low interest rates, which have triggered the current property market boom.

It’s important to get your head around how to use debt and the notion of good debt versus bad debt.

Now, if you’re currently debt free, hats off. In this day and age, it’s no mean feat.

But not all debt is necessarily bad.

In fact, from a wealth-building perspective, it can mean the difference between retiring early or having to keep working well into, say, your seventies.

In other words, good debt can help you create wealth, while bad debt will typically serve to reduce your wealth.

So, how to use debt? I’ll break it down for you…

Good debt

The old adage, ‘it takes money to make money’, is invariably true.

Ultimately, debt that helps you buy assets that’ll appreciate in value and generate an income – such as buying a house or apartment – is widely considered ‘good’.

The other consideration here is that good debt can also help reduce your taxable income in some instances.

Bad debt

It’s all pretty logical, but I’d describe bad debt as borrowing money to buy goods that tick the following boxes:

  • will depreciate in value,
  • won’t generate any income and
  • are not tax deductible.

I’m talking putting a holiday on your credit card or having to have the latest Mercedes-Benz and overextending yourself with a personal loan.

My general rule here is this: if you can’t afford it and don’t need it, then don’t buy it.

Borrowing for general stuff

Structurally, credit cards and personal loans are very similar products, accruing interest and requiring monthly repayments.

Let’s start with credit cards.

Consider this: Australia’s national credit card balance currently sits at $52B, two-thirds of which is accruing interest.

I’m a believer that credit cards should only be used for short-term transactional debt where you know you can pay it off within the interest-free period.

Anything else, forget it. Unless it’s an absolute emergency, obviously.

Now onto personal loans.

In my mind, these should be used for consolidating debt, given that they have a maximum loan term, ensuring the debt is repaid with a fixed term (unlike credit cards, which can become a self-fulfilling prophecy in terms of accruing debt).

My opinion: bad 

Borrowing for a car

Cars are a bit of a grey area for me, particularly when you consider how much most models depreciate over the first five years and beyond.

While I love driving a nice car – who doesn’t love that ‘new car’ smell, right?! – I see them as a luxury, given that you’re paying interest on something that depreciates in value and that it will be worth significantly less at the end of the loan period.

My opinion: bad

Borrowing for education

A seemingly large student debt can be a little overwhelming in your late teens, early twenties.

For me, investing in your education – and your future earning ability – is one of the best investments you can make.

What’s more, the debt only increases with CPI, there’s no interest and you won’t have to begin repaying it until you start earning over the $55,874, the current repayment threshold.

My opinion: good

Borrowing for property

First, owning your own home is likely to be the most profitable investment your family will ever likely make.

Here, home loans have a lot going for them right now. Interest rates are low, you get to own your home rather than pay rent and the loan’s backed by a property that, over time, will typically increase while the loan balance decreases.

Better still, a few simple strategies will help you pay it off sooner.

Strategies like parking spare cash into your loan instead of a separate savings account, for example, will help reduce interest charges, whittle away the principal and, if you need cash, a redraw facility will give you easy access to your money if you need it.

My opinion: good

Borrowing for investment

If it’s an investment property, it ticks all the right boxes.

Ultimately, this type of credit gives investors access to low-interest rates as well as capital growth on a rental property.

It’s also tax friendly, meaning the interest on the loan can typically be claimed on tax. Provided you can comfortably cover the repayments, this can be a great way to grow your personal wealth.

My opinion: good

Borrowing for small business

For me, the first boxes you’ll need to tick are:

  • Do I have a solid business idea? And,
  • Do I have a sound, robust business plan to get it off the ground?

If you do, I’d say go for it, particularly if you can see a clear-cut pathway to becoming profitable but don’t have the necessary capital to get it off the ground.

My opinion: good

Whichever way you look at it, debt always comes with a degree of risk, even good debt.

It all comes down to how much debt you can comfortably repay and preparing for when something goes wrong – like if the market tanks or you struggle to find a tenant for your investment property, for instance.

If it’s something that’s going to consistently keep you up at night and put pressure on your family, I’d encourage you to reconsider or seek professional advice.

As always, if you need to talk through anything I’ve discussed in greater detail or want to soundboard some debt scenarios, please give me a shout.

Disclaimer: all information contained within this article is of a general nature. It does not take into consideration your personal financial circumstances. Please consult a professional financial adviser (just like us 🙂 ) when making a financial decision.

Jason Chew

I've been in the financial services industry for 10+ years and love coaching people to make the most of what they have.

  • Gary Pope
    Posted at 09:19h, 18 July Reply

    Well explained, as usual, Michael! $52B on national credit cards – that’s quite a figure. I agree with each of your summations. Keep up the terrific blogs! Gary, The Basin VIC.

    • Michael Chew
      Posted at 14:29h, 31 July Reply

      Hi Gary, Thanks for your support and comments. Michael

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