The truth about good debt

It goes against everything we’ve been told about debt, but borrowing money can be a key strategy in building a stronger financial future.

Disclaimer: The information contained in this article is of a general nature only and should not be taken as financial or legal advice on any of the topics discussed. Always consult a financial adviser before making any investment decisions.

At some point, most Australians will dream about purchasing their own home. This usually means having to take on a mortgage. In today’s market, it’s simply not enough to demonstrate your ability to save for a required deposit. Knowing this, the right kind of debt can serve a purpose.

The key to securing the best deal for your financial situation is in having a good credit history. This will be built over time to reflect your financial behaviour, such as meeting loan and bill payments.

So, what is good debt? Before you take out your credit card, it’s important to consider your needs versus your wants.

Let’s talk about good debt

Good debt is any borrowing that will help you access or leverage financial value or longer term income. An example of this might be a student loan which finances your further education. This will present longer term opportunities, both in your professional life and for your future income.

However, given that student loan repayments are directed to the Australian Tax Office, they won’t be reflected in your credit history. Other “good debt” options that may be reflected in your history include borrowing for a vehicle or for investment.

Do we have to talk about bad debt?

If you want to have the financial freedom to choose the life you want, you’re going to need to make smart decisions about your debt.

Bad debt is rarely attached to an asset that appreciates in value, and will only diminish your financial position over time.

Bad debt may include things such as buying clothes, gadgets, entertainment, nights out and holidays on your credit card. Before any purchase, ask how it will help build your financial future. There’s no reason to pay for a new outfit on your credit card, especially if you can’t afford to pay for the subsequent night out in cash.

If you’ve ever maxed out your credit card, it’s easy to remember how the interest payments to cut into your weekly budget. With the automation of credit transactions through subscriptions, direct debits and memberships, it’s more important than ever to keep track of your monthly purchases and any outstanding balances.

To make sure you’re positioning yourself for financial success, always think carefully before taking on any new debt. This begins with calculating a realistic budget you can stick with.

Your strategy for building wealth

You should only look at building wealth through borrowing money if you want to build your credit rating or make purchases that will add value, such as assets.

Depending on your tax rate, you may be entitled to other benefits when you borrow for property or share market investment, which is known as gearing. When calculating the overall implications of this strategy, you will need to consider the possible tax deductions, interest rate, income risk, fees and charges and the flexibility of the investment should you ever need to exit.

ASIC nominates 5 steps towards financial security that begins with having a full picture of your finances. Before entering into the lending market, it’s important to remember the importance of not only borrowing within your means, but borrowing for something that is going to add some value to your life. When taking on any debt, always make sure it helps meet all of your longer term needs.

And before making any commitment, first ensure that you seek professional advice when it comes to your finances, and research all your lending options. For example, investigate all fees and charges, penalties, terms and conditions and market interest rates.