According to ABS statistics released in October 2017, Australian Household Debt levels have risen at an alarming rate.
The most common form of debt was credit card debt, held by 55% of households, followed by home loans (34%) and student loans (17%).
Like much in life, too much of anything may not be good for you. In recent times, many people have started referring to credit (or debt) in two ways – good debt and bad debt.
As you get closer to finishing school, perhaps taking on a part-time job and building your savings to make some of your own purchases, it is important to understand the difference between good debt and bad debt.
Good debt is where you take on debt to grow your income, such as purchasing an investment asset. The income from the asset helps pay back the interest and principal of the loan. When used appropriately, this can be a useful tool for building wealth over the long term.
An example is where people take out an investment loan to purchase a rental property. Remember though, even good debt can have its challenges and isn’t always a one-way street to wealth.
Bad debt is where you take on credit to fund your lifestyle, day-to-day costs, or assets that lose value over time.
This adds a financial burden to your budget and while you may have a better lifestyle in the short term, it is not sustainable and can erode or destroy your wealth over time. Examples of bad debt can be using credit to buy clothes, holidays, fast food, household appliances, and even cars.
Credit cards and personal loans are most often used for lifestyle purchases and can create major headaches.
Ask yourself a few key questions:
Do you really need the purchase?
Will the additional financial burden of the interest and repayments be covered by your regular income?
Can you accommodate the interest and repayments, even if interest rates go up or your income dips?
Only if you can answer yes to these questions, should you proceed – and even then, carefully.
Remember, make sure you do your homework and get good advice before you take on debt.
Check out our resource about debt which can help you have a conversation about this important topic in your classroom: http://www.financialbasics.org.au/flip/slaying-the-debt-dragon.aspx
This article was written by Darren Stacy, Executive Director, Debt Advisory, BDO in Australia