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Good Debt vs. Bad Debt

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For many Australians, debt is a fact of life. At its most basic definition, debt is simply an amount of money borrowed by one party from another. But it’s important to note that not all debts are created equal. From home loans to credit cards – some debts are good and others bad. But how do you tell the difference?

Good Debt

Good debt helps you generate income and adds value to your net worth. Some popular examples include:

  1. Education
    Upskilling is considered good debt. Whether it’s technical training or a university degree, in general, the more education one has, the greater their earning potential. Investing in your education can earn you money in the long-term.
  2. Property
    Property ownership, even in the form of a home loan, is generally regarded as being good debt. On a larger scale, real estate can be an excellent source of cash flow and capital gain for investors. Owning your home increases your value, and therefore is not considered bad debt.
  3. Business Ownership
    The primary purpose of a business is to make money – although the adage of ‘spend money to make money’ is often true with a small business. But, with a bit of luck, your business can lead to significant increases in income and become a valuable asset.
  4. Investment
    Investing provides an opportunity to generate income. From stocks and bonds to commodities and futures, there is a wide range of investment opportunities. With proper due diligence and risk management, investing can generate wealth, making it a good debt. 

Be warned

While these categories are often regarded as being ‘good debt’ it’s important to note that there is no one size fits all rule, and all debt carries risk. An education is not a guaranteed ticket to wealth or employment; no business is guaranteed market success; the property market can fluctuate; and investing can be complex and volatile.

Bad debt

Even though good debts are risky – some debts are considered categorically bad.  Bad debts are when the thing you’ve purchased won’t go up in value or generate income. The two main examples include:

  1. Clothes, consumables and other goods
    Expensive clothing, technologies, nights on the town – these are items that usually shouldn’t be bought on borrowed money.  They don’t increase your net worth or generate money, and are therefore considered a loss.
  2. Credit cards
    Credit cards are the most well-known form of ‘bad debt’.  Credit card interest rates tend to be higher than those on personal loans, maximising cost to the customer. Owing money on a credit card can often cost more than the convenience they offer.

There is no golden rule when it comes to debt. Many might argue that there is no such thing as good debt. The reality is most people will encounter debt in some form in their life. But it’s worth considering if your spending is taking into account the long-term benefits and pitfalls, and to remember that even good debt can have its downside.

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