For many people, living in debt is a fact of life. It’s a way to temporarily cover small things like a tank of fuel or concert tickets, or much larger, much longer-term things like a home. In its most simple form, debt is an amount of money borrowed by one party from another. When we look at debt as a whole, it’s all essentially the same. We take now and give back later.
Understanding how to best manage your debt is key to keeping your finances under control. Firstly, it's important to consider there are two types of debt, good debt and bad debt.
What is good debt?
Good debt is the type of debt that helps you improve your financial wellbeing. An example of this is education. Generally speaking, spending money on training, university or TAFE will lead to a better job and pay packet. It’s essentially a 'you get out what you put in' sort of situation. It can be expensive and take a while to complete, but what you pay for a university degree or industry-specific training can deliver a return to you in the form of an increased salary and you will be better off long term.
Another great example is real estate. You might get a home loan, buy a house and live in it for a while before you sell it and hopefully make a tidy profit. Similar to investing, this form of good debt takes time to pay off.
What is bad debt?
It's always the things we love most that end up hurting us. For some it's cars, for others it's shoes and for most, it's whatever we throw on our credit card. Bad debt occurs when we purchase something that will drop in value or stretches our ability to meet repayments. For instance, a new car will drop in value as soon as you drive it out of the dealership. Of course, cars are incredibly useful and often necessary, but if you’re looking to keep more money in your pocket, don't expect a car to pay the bills.
Credit cards, personal loans, "no interest for 12 months" and, potentially worst of all, pay-day lending, can mean high interest rates. It might mean you end up paying more in interest than. you did for the original product once interest starts to accrue faster than you pay it off.
Worth taking a moment
Before going into debt, you may find it helpful to consider this question.
If whatever you're buying won't go up in value or generate more money for you, is it worth putting yourself in debt for?
It sounds very simple and straightforward, but life tends to throw some curveballs when you’re not looking, so be aware that there can be significant consequences if you rely too heavily on debt to pay for the things you want.
Remember to make yourself aware of what you’re getting yourself into, keep up to date with how you’re tracking and, ideally be patient and put money aside to save for those ‘nice-to-haves’, especially while you’re paying off your mortgage.
Are you experiencing financial difficulty?