Good debt vs bad debt

Is there such as a thing as good debt? When people think of the word 'debt', they usually associate this with an inability to pay their bills by the due date. However, while these debts are generally bad and should be avoided, there are debts that can be considered an investment and can help increase your overall financial position, known as good debt.

According to financial planners AMP, good debt is when you borrow to invest and your investment is income-producing, making the interest you pay on the loan tax-deductible. This usually involves an asset which increases in value over time, such as a property or shares.

Property, for example, cannot usually be paid off in one go and involves paying off the mortgage in several instalments that may take years to settle. While this means that you are living with debt, this is an investment that appreciates in value and generates further income, either through rental or the sale of the house for a higher price in the future.  Similarly, a student loan taken out to pay for a university education is also a beneficial investment as it is generally assumed that you can command a higher salary with a degree.

Good debt, like its name suggests, is good for you in the long run and shouldn't be avoided at all costs. In fact, if you are investing in something as major as a home, it is better to incur this debt rather than paying upfront as this may place a strain on your cash flow or even wipe out your emergency funding. However, remaining in control of your debt and having the capacity to pay it off is still crucial to gaining good financial health.

On the other hand, bad consumer debt occurs when you borrow to invest but the value of the investment drops over time, according to AMP. This means that the asset is non-income producing and interest on the loan is not tax-deductible, for instance credit card debt. Incurring a debt on your credit card is dangerous as it usually has high interest rates that can snowball over time; and also makes it easy for you to spend more than you can afford, especially if your limit is higher than your monthly salary. Other forms of bad debt include car loans and holiday debt.

To prevent bad debt, ensure you keep track of all your credit commitments, especially their due dates, and make sure that you can afford to pay off all lines of credit in full each month. You should also minimise the number of unnecessary purchases you make on your credit card if you are experiencing financial strain - avoid accumulating debt to purchase items such as clothing, food or holidays as these items only depreciate in value over time.

However, if you already have some form of bad debt, you can still work to reduce it if you set yourself a goal, such as taking out a lower-interest credit card or loan, switching to a debit card, making monthly repayments in full, or look for zero per cent balance transfers. You can also consider reducing your credit card limit or get professional help from a financial planner. Only by evaluating your current financial position and working towards these goals can you then consolidate your debt.