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 head above water in the short term, as well as thinking of your blood pressure long term.
Understanding how to best manage your debt is key to keeping your head above water in the short term, as well as thinking of your blood pressure long term.
The truth of the matter is that money doesn’t grow on trees, or any type of plant for that matter. Good debt is the type of debt that helps you to add to your overall 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. From a residential point view, you get a mortgage, 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, which raises an interesting point. Risk.
We’re all aware that life doesn’t come with a guarantee, so getting into any form of debt (even if it’s seen positively) has a level of uncertainty. So, do your research, ask questions and stay on top of your repayments to avoid ending up in the red.
It’s always the things we love most that end up hurting us. For some it’s cars, for other 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, car loans, “no interest for 12 months” and, potentially worst of all, pay-day lending, can mean astronomical interest rates. It won’t take long for you to have paid as much in interest as you did for the original product once interest starts to accrue faster than you pay it off.
If there’s one point that you can take from this, it’s this:
If whatever you're buying won't go up in value or generate more money for you, it's rarely worth putting yourself in debt for.
It sounds very simple and straight forward, but life tends to throw some curve balls 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.
Also, if you find yourself in a sticky situation, put your hand up sooner rather than later. Speak with your financial institution; it is in their best interest to try to help you work through a problem, rather than wait until it’s too late. There’s no shame in hitting a financial iceberg, what’s important is that it doesn’t make you sink.
For more information, visit the MoneySmart.
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