For many Australian adults, debt is a part of our everyday lives. Whether or not you intend to enhance your skills by obtaining a degree, invest in a house for your family, or buy a vehicle so your family has transportation, obtaining a loan is very common simply because we don’t have enough money to pay for these costs upfront. It appears that everybody gets a loan at one point or another, so what’s the problem?
The trouble is that lots of individuals don’t appreciate the difference between good debt and bad debt, and as a result, they take on too much bad debt which can bring about significant financial problems in the future. Not all loans are created equal, and commonly you’ll find a huge difference between your credit card interest rates and your home loan interest rates. As time go on, your credit report will have a critical effect on your borrowing abilities, so paying your bills on time and not defaulting on any loans is essential, coupled with keeping a healthy balance between good debt and bad debt.
Each time you request a line of credit, your financial institution will check your credit report to assess your financial history and then determine whether they’ll endorse your loan. Too much bad debt on your credit report will be viewed negatively by lenders, as it displays poor financial decisions and behaviours. To ensure that you maintain healthy financial practices, it’s important that you are aware of the difference between good debt and bad debt.
What’s the difference?
The difference between good debt and bad debt is relatively straightforward. Good debt is usually an investment that will increase in value in time and will support you in generating wealth or providing long-term income. Conversely, bad debt typically decreases in value rapidly and does not add any value to your wealth or earn a long-term return. To give you some understanding, the following gives some examples of each of these types of debts.
The price of land has historically increased over time, so securing a mortgage is considered a good debt because the value of your land will increase in time. On top of that, home loans typically have low interest rates and a long term, normally 20 to 30 years, which illustrates that the value of your property can double or triple during the life of your loan.
Taking out a loan to invest in the stock market is also deemed to be good debt because the returns on the stock exchange are historically favourable. Lending institutions generally view stock exchange loans as good debt because you are attempting to improve your wealth with time through a solid investment. Be careful though, it’s not wise to invest in the stock market unless you have an acceptable amount of knowledge.
Another kind of good debt is investing in your education, whether it be university or a trade, because it increases your skills and your potential 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 attractive option.
Credit cards are commonly the worst type of debt a person can have. Credit card debts reveals to lenders that you have poor financial habits because the interest rates are incredibly high and you have nothing in value to show for your investment. Folks with credit card debts usually have troubles in securing future credit from lenders.
Vehicles and consumer goods
Another type of bad debt is loans for cars and other consumer goods. When you obtain a loan to buy a vehicle, it instantly decreases in value when you drive it out of the car dealership. The same applies to consumer goods like flat screen TVs, because you are effectively paying interest for something that depreciates in value very rapidly.
Borrowing to repay debt
If you end up in a situation where you have to secure a loan to repay existing debt, it’s best to seek financial support as soon as possible. This type of borrowing will only bring about further money problems, and the sooner you act, the more solutions will be available to you to resolve the issue. If you end up dealing with a mountain of debt, reach out to the professionals at Bankruptcy Experts Whitsundays on 1300 795 575, or alternatively visit our website for additional information: Insolvency Whitsundays