Good versus bad debt.

Mention the word ‘debt’ and we tend to have negative associations. It’s true that debt needs to be managed wisely. However, it’s also fair to say that without debt we wouldn’t be able to tick off key personal goals like buying a car, owning a home or investing in a rental property.

That’s why the key to managing debt is to understand the difference between good and bad debt.

The rewards of good debt.

Picking ‘good’ debt is easy. It’s the type of debt we use to buy assets that build wealth or increase in value over time.

One of the best examples of good debt is a home loan. It goes to fund an asset–your home–which can skyrocket in value as the years go by while you reduce the loan by making steady, ongoing repayments.

Think of it this way. Ten years ago, the median home value across Australia’s state capitals was $462,5001. At the time–just as today–plenty of home buyers needed a home loan to get into the property market.

Fast forward to August 2021, and the median capital city home value is $740,4752. That’s a rise of $280,000 in just 10 years. Yet if you’d taken out a home loan back in 2011, your loan balance could have halved by now.

Long story short, ‘good’ debt funds an asset that goes up in value, while your debt goes down with loan repayments. Brilliant!

When it comes to good debt, it’s still important to look for a low rate and flexible features. Defence Bank home loans tick all the boxes, letting you choose from a low-cost, no-frills loan to a fully-featured DHOAS home loan.

Spotting bad debt.

Bad debt is quite different. This is debt used to buy things that can be ‘here today, gone tomorrow’. In other words, purchases of no lasting value.

An example of ‘bad debt’ can be owing money on a high-interest credit card to pay for things like groceries, something that doesn’t last long in most households. If you don’t pay the debt off in full in the interest-free period, you could end up adding 15%-plus (or whatever the card rate is) to the cost of the purchases.

While owning a credit card is not bad in itself as they are one of the quickest ways you can build up a good credit rating, high-interest charges can make it harder to pay off the balance and set you on a debt treadmill where you’re continually struggling to get ahead.

That’s why it pays to look for a low rate credit card with generous interest-free days. Then aim to clear the slate before interest charges apply.

‘Necessary debt’.

Somewhere between good and bad debt lies ‘necessary’ debt. That’s the type of debt used to fund big-ticket buys that are hard to save for.

A great example of necessary debt is a car loan. Sure, you could save up for a car. But if you want to buy a quality car as opposed to a cheap rust bucket that will bring you no end of trouble, you’re likely going to need a loan to pay the purchase price.

Cars tend to depreciate rapidly. So it makes sense to look for a low rate car loan – preferably one you can pay off sooner rather than later.

A Defence Bank car loan offers a competitive rate and low fees, and goes a step further - you can make fee-free extra repayments to clear the debt faster. Plus, you’ll pay zero penalties if you pay off the loan ahead of schedule. It lets you buy the car you need while minimising interest costs – and that’s a textbook way to manage necessary debt.

You can count on Australia’s Defence Bank to take you through the debt options available – for whatever you need, for whatever’s ahead. Call our Contact Centre on 1800 033 139, or visit your local branch to find out more.

Got questions? We have the answers. See our FAQs.

 

1 RP Data‐Rismark Hedonic Home Value Index 29 July 2011.
2 CoreLogic Hedonic Home Value Index 2 August 2021.

 

Important note: This information is of a general nature and is not intended to be relied on by you as advice in any particular matter. You should contact us at Defence Bank to discuss how this information may apply to your circumstances.

 

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