Why debt is not always a dirty word

• What is good debt? By strict definition, a good debt is one you take on for investment purposes, where the loan will get you a good return for your money and the payments are tax-deductible. But as Financial Services Director at RSM Australia Grace Bacon explains, this definition is a bit narrow and rigid, leading some debt we would typically consider good to be filed into the “bad” column. She says good debt should be considered in light of your personal circumstances, but generally a debt can be considered positive if it helps you build wealth and reach your financial objectives, isn’t overly onerous to maintain, and where you get back more than you pay for. Keep in mind what you’re getting back doesn’t have to be a financial return – in the case of a mortgage, what you’re getting back is a place to live (unless it’s an investment property, but that’s a different kettle of fish). Under this umbrella, student debt is considered good, mortgages are (generally) considered good, and so too are business loans, provided they help build the business, not bail it out of insolvency.

• So what’s bad debt? Bad debt is a bit less obtuse than good debt, and is generally when the loan is short-term with high repayments or interest, meaning it is more challenging to pay off. Bad debts often don’t result in the same long-term gain as a good debt, and can pull people into a vicious “debt cycle”, where they’re forced to take out new loans to repay other loans they’re struggling with. Examples of bad debt include credit cards, car loans, payday loans, personal loans, and buy now, pay later services (sorry Afterpay fans). However, while the definition of bad debt seems pretty clear-cut, as Bacon says, “any debt is bad if you can’t pay it back”.

• Why does it matter? Other than weighing you down financially, bad debts can be bad news when it comes to other aspects of your financial life, says Rebecca Jarrett-Dalton, founder and mortgage broker at Two Red Shoes. “Bad debts reduce your borrowing capacity and impact your ‘creditworthiness’ in a lender’s perception – having a poor ratio of debts to assets makes you look like a poor candidate for lending,” she says. “All too often we see people with great income but carrying so many accumulated repayments that they are perpetually in a debt cycle with no spare cashflow.”
• What should you do? If you’re in debt, the first thing to do is spend some time categorising which debts are good or bad. Then, choose your debt with the highest interest rate and focus on paying that down first. Once you’ve done that, move onto the next highest, and so on. You can always reach out for help if your debts are feeling overwhelming by contacting the National Debt Helpline (1800 007 007), which can put you in touch with a free financial counsellor to support you.

Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.