Is there such a thing as good debt?

It may go against everything you’ve been told, but borrowing money may 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 stage in their lives, most Australians will dream of owning their own home. This typically goes hand-in-hand with a mortgage. To secure the best home-loan deal in today’s market, it’s simply not enough to demonstrate that you can meet a regular savings commitment.

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

So, what is good debt? Before you whip out the credit card, it’s important to take a look at your needs versus your wants.

Good debt

Good debt is borrowing that can help you to access or leverage financial value or longer term income. An example might be a student loan which finances your further education. This will open up longer term opportunities, in both your professional life and with your income.

While student loan repayments are directed by the Australian Tax Office and aren’t reflected in your credit history, there are other “good debt” options that will affect your credit history – these include borrowing for a vehicle or for investment.

Bad debt

To have the financial freedom to choose the kind of life you want, you will need to make smart decisions about your debt.

Bad debt is rarely attached to an asset that appreciates in value over time. Keeping this in mind, it makes sense that taking on bad debt will damage your financial position.

Bad debt could include using your credit card to buy clothes, gadgets, entertainment, nights out or holidays. Before making any purchase, ask yourself how it will affect your financial future. There’s no reason to pay for a new outfit with your credit card, especially if you can’t afford to pay for the night out in cash.

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

To ensure that you are positioning yourself for financial success, always think twice before taking on any debt. This all begins with calculating a realistic budget you can stick with.

A strategy to build wealth

When building wealth, you should only borrow money if your aim is to build up a credit rating or make purchases that will add value, such as assets.

Depending on your taxation rate, you may be entitled to other benefits when borrowing for property or share market investment. This is known as gearing. When calculating the overall implications of this strategy, you’ll also 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 borrowing, it’s important that you not only borrow within your means, but that your borrowing is for something that will add some kind of value to your life. Always ensure that everything you borrow will help you succeed in ways that will meet all of your long-term goals.

Before making any commitment, first make sure that you seek professional advice in regards to your finances, and always research your lending options. For example, research all fees and charges, penalties, terms and conditions and market interest rates.