What is good debt versus bad debt?

Not all debt is bad for building wealth. Understanding the difference between good and bad debt could help you make better financial decisions.

 

Good debt

Debt is generally considered to be 'good' or positive if it helps you purchase wealth-building assets - meaning assets that are likely to give you an income and/or grow in value over time. Good debt may also be tax deductible.

An example is borrowing money to purchase a home or an investment property, which may appreciate in value over the longer term.

In the case of an investment property, the owner may be able to use the rental income from the property to help pay off the investment home loan.

Investors may also be entitled to a tax deduction known as negative gearing if the loan repayments exceed the rental income earned on the property.

 

Bad debt

Debt may be viewed as 'bad' or detrimental for your wealth if it is used to buy assets that will fall in value, won't earn you any money and are not tax deductible.

Using a credit card or a personal loan to fund things like luxury goods and holidays is also considered an example of taking on bad debt.

 

Can bad debt ever be good?

Arguably bad debt can help you manage your finances and achieve a positive outcome.

If you are disciplined and pay off your credit card debts at the end of the month you have used the credit card as positive way to manage your cash flow.

This might enable you to keep your money sitting longer in a savings account, for example, where it may earn you interest.

Credit card debt becomes bad when you purchase luxury goods that you cannot afford and begin to live beyond your means. This can result in high monthly interest payments accruing over time, which may become increasingly difficult to pay off.

 

Can good debt ever be bad?

Using good debt to pay off bad debt could cost you years in extra interest payments.

An example could be consolidating bad debt into a personal loan or borrowing more on a mortgage.

If, for example, you take out a mortgage for $310,000 with the intention of using $10,000 to pay off existing debt, the end result is that you spread the repayment of the debt out over a longer period of time. This means it will probably cost you more in interest payments.

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