For almost all Australian adults, debt is a part of our daily lives. Whether or not you would like to further your skills by earning a degree, purchase a home for your family, or purchase a car so your family has transport, securing a loan is very common simply because we don’t have sufficient money to pay for these expenses upfront. It seems that everyone obtains a loan at one point or another, so what’s the problem?
The trouble is that too many people don’t grasp the difference between good debt and bad debt, and consequently, they take on too much bad debt which can cause substantial financial problems down the road. Not all loans are created equal, and generally you’ll discover a huge difference between your credit card interest rates and your home loan interest rates. Over time, your credit report will have a serious effect on your borrowing capacity, so paying your bills on time and not defaulting on any loans is critical, coupled with keeping a healthy balance between good debt and bad debt.
Each time you request a line of credit, your lender will review your credit report to determine your financial history and then decide whether they’ll approve your loan. Too much bad debt on your credit report will be viewed negatively by financial institutions, as it exhibits poor financial decisions and behaviours. To make certain that you maintain healthy financial habits, it’s important that you recognise the difference between good debt and bad debt.
What’s the difference?
The difference between good debt and bad debt is fairly straightforward. Good debt is commonly an investment that will increase in value over time and will support you in constructing wealth or providing long-term income. Meanwhile, bad debt primarily decreases in value rapidly and does not add any value to your wealth or create a long-term return. To give you some understanding, the following gives some examples of each of these types of debts.
The price of property has traditionally increased in time, so obtaining a home loan is considered a good debt because the value of your land will increase with time. Furthermore, home loans often have low interest rates and a long term, normally 20 to 30 years, which illustrates that the value of your home can double or triple during the life of your loan.
Taking out a loan to invest in the stock exchange is also deemed to be good debt simply because the returns on the stock exchange are historically favourable. Financial institutions generally view stock exchange loans as good debt because you are attempting to increase your wealth in time through a stable investment. Be careful though, it’s not a good idea to invest in the stock exchange unless you have a sufficient amount of knowledge.
Another type of good debt is investing in your education, whether it be university or a trade, given that it boosts your skills and your ability to earn a higher income in the future. In Australia, the interest on HECS loans are equal to inflation which clearly makes them a very enticing option.
Credit cards are normally the worst type of debt a person can have. Credit card debts reveals to creditors that you have poor financial habits because the interest rates are extremely high and you have nothing in value to show for your investment. People with credit card debts often have complications in acquiring future credit from creditors.
Cars and consumer goods
Another type of bad debt is loans for vehicles and other consumer goods. When you obtain a loan to purchase a car, it immediately decreases in value when you drive it out of the dealership. The same applies to consumer goods like flat screen TVs, because you are essentially paying interest for something that depreciates in value very fast.
Borrowing to repay debt
If you find yourself in a position where you have to get a loan to repay existing debt, it’s best to seek financial support immediately. This type of borrowing will only bring on further money problems, and the sooner you act, the more solutions will be available to you to resolve the issue. If you end up facing a mountain of debt, talk to the professionals at Bankruptcy Experts Darwin on 1300 795 575, or alternatively visit our website for further information: Declaring Bankruptcy Darwin