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Manage good debt, minimise bad debt
By Tammy Barton

Financial health money and stethoscopeGood vs. bad debt

Living a life which is completely and forever debt-free is a situation few Australians will ever experience. Nearly all people who buy a home rely on a mortgage to be able to do so.
But many people also rely on credit to finance their everyday expenses, such as groceries, clothes and entertainment. Credit cards (the old “plastic fantastic”) make it easier than ever to accumulate debt—often more debt than the individual can afford to pay back. That’s why it’s important to understand the difference between good debt and bad debt.
Good debt is usually associated with loans for investments that reliably increase in value. Purchasing a home has been an example of this. Historically, capital growth in home values in Australia have made mortgages a good long-term investment. You can also rent out a residential or commercial property to earn income from it.
Bad debt is usually associated with loans for things that lose value. Clothes, groceries, holidays, furniture, entertaining, eating out—they may feel good at the time, but they leave nothing of real value to show for your purchases. Even furniture—unless they’re antique or collectable items—will quickly lose value. With bad debt, your debt is very likely larger than the intrinsic value of the item you purchased. You may also end up paying interest charges on it for months or years to come.
There are, of course, some debts which blur the line between good and bad debt. New cars lose value quickly, but having reliable transport is often essential to holding down a job. The key with a car loan is to buy the car you need, which may not necessarily be the car you want.

Minimise bad debt by:

  • Using cash, not credit, for your living expenses and everyday purchases.
  • Creating a budget which incorporates all of your expenses and a savings plan.
  • Saving up for the things you want to buy.
  • Buying what you need rather than what you want.
  • Paying your credit card balance in full every month—even better, cut it up and use cash or a debit card.

Manage good debt by:

  • Not over-committing yourself.
  • Creating a budget which anticipates interest rate rises—would you be able to afford your loan payments if interest rates were to rise?
  • Paying more than the minimum required instalment on your loan.
  • Doing your research—understand that investments are usually long-term propositions and that some investments perform better than others.
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