Good debt vs bad debt

It’s likely that some time you will consider taking out a loan. If you can purchase without borrowing, say by using existing savings, or delaying your expenditure, you can avoid the fees and charges associated with a loan.

When making decisions about borrowing it is important to know the difference between good and bad debt.

Good debt:

• Is an investment in your future
• Has a clear reason for taking it out
• Has a realistic plan for paying it back
• Uses the cheapest way of borrowing money (including all fees and charges)

Bad debt:

• Eats into future wealth
• Is unaffordable – you cannot meet the monthly repayments
• Is used for purchases of items that are beyond your means
• Includes borrowing money to pay monthly bills

Thinking about borrowing?

Some useful things to think about when considering borrowing money are:

• What is the purpose of the loan:
  • Do you need to spend the money now?
  • Why are you choosing to borrow?
  • Could your savings cover the purchase?

• Are there alternatives for your planned purchase?
  • Could you find an affordable alternative such as a second hand item?
  • What would be the relative advantages and disadvantages for you?

• What is the true cost of the loan: (online calculators are available)
  • What is the interest rate for borrowing?
  • What are the fees?

• Are the repayments affordable for you now? In the future? (Think about your current and expected earnings)

• Do you qualify for a No Interest Loan? The No Interest Loan Scheme (NILS) provides individuals and families on low incomes with access to safe, fair and affordable credit.

• Know who and what you are dealing with:
  • Who is the lender?
  • What is in the contract?

• What answers would you get if you ask these questions about your current loan(s)?

Borrowing basics

You can borrow from a range of banks and financial institutions. To take out a loan you need to provide identification to prove that you are who you say you are. When choosing a loan type and  lender, you should be aware of all of the loan’s features and compare across lenders to make sure you are getting the loan that best suits your needs.

Loan features include:

• Interest rate for the loan – is the rate fixed for the life of the loan or can the lender change it?
• Fees and charges associated with the loan – establishment fees are common
• Penalties for early/late repayment
• Size of the loan
• Length of the loan (the number of months or years)
• Amount of the repayments
• Reputation of the lender
• What you can afford to repay, given your existing financial commitments.

Some people use their family and/or friends as a source of loans. For larger amounts, you could consider entering into a formal agreement that covers the details of the loan, how and when the loan will be repaid and the consequences of non-repayment.

Types of debt

This segment covers a broad range of debt types and includes activities relating to different debt types. Later in the topic, activities allow you to investigate the types of loans that are relevant to you.

Debt basics

There are different kinds of debt, and the cost can vary significantly.

• Credit cards are used for their convenience and flexibility but are an expensive method of borrowing.
• Personal loans can be a cheaper alternative to credit card debt, but the interest rates are still high
• HECS-HELP used for undergraduate degrees has a low effective rate of interest
• Payday loans have very high interest rates.
• Car loans and mortgages are provided by many lenders and shopping around for the best deal can save money.

All loans have fees and charges – if you know what they are, you can choose to borrow at the lowest cost.

Interest free deals

Deal or no deal?

A well-known store offers its customers “50 months interest free” on furniture purchases. Does this sound like a good deal? On the face of it it does, but it depends on what is in the fine print.

• Some stores require you to acquire a credit card which has an establishment fee and monthly account fees
• If there is an outstanding balance at the end of the 50 months very high rates of interest get charged

There are a variety of products and ways that interest free periods are offered. The general principles are:

• Read the fine print
• Interest free does not mean cost free.
• Very high rates of interest are charged if the amount is not repaid within the interest free period

Recognising debt problems

A problem with debt can happen to anyone, often due to circumstances beyond your control.

Problems with debt arise when your current income and savings do not cover your required repayments and other expenses. There are a range of potential triggers for debt problems that can include:

• Ill health/disability
• Loss of job
• Moving house
• Easy access to credit
• Insufficient awareness of loan conditions
• Accidental damage
• Relationship breakdown
• Drug or alcohol dependency
• Problem gambling

When debt problems arise, it is essential to take action quickly and seek help.

Understanding of the consequences of debt can help you to appreciate the seriousness of debt problems.

Debt problems can affect:

• Your relationships with family and friends – you may avoid people due to shame, anger and/or embarrassment
• Your emotional, mental and physical wellbeing
• Your ability to take out loans in the future.

Financial problems are often not spoken about within society, so it can be difficult to recognise when debts are becoming a problem.

Taking control of debts

Ignoring debt problems does not make them go away. In fact, ignoring debts means the problem will get bigger, not smaller. Taking action quickly and seeking help are important steps.

Having debt problems means that you will need to prioritise your debts.

• Consider the consequences of not meeting or managing each debt, rather than the amount of hassling you are getting about each debt
• You could give the highest priority to debts with the most serious consequences e.g. not paying your rent could leave you homeless
• You could prioritise debts with higher interest rates over those with lower interest rates.

Debt problem help

Sources of help for debt problems include:

• Talking to the lender – they may temporarily reduce your repayments
• Asking for help – financial counsellors are trained professionals who can help with solving debt problems
• Asking for help – National Debt Helpline 1800 007 007
• Free legal advice – you can access free legal advice relating to your debts through Community Legal Centres if you cannot afford a private solicitor
• ASIC’s MoneySmart website has more information on managing debts here: Managing debts