Imagine living debt free. No loans to repay. No interest costs chewing up your disposable income. Completely financially self sufficient. At a recent lunch this was the premise of our conversation. Of course, I casually mentioned, it’s not always feasible to live debt free. That’s why we try to make smart debt choices, utilising good debt and avoiding bad debt.
One friend laughed as she excitedly told us how they were completely paying off their home loan within five to ten years. Heads nodded with encouraging affirmations. She was smiling as she went over to pay for her meal. With a flick of her wrist she passed over the credit card. That’s when her smile dropped into an embarrassed sigh as her card was declined.
They’d basically been replacing good debt with bad debt. Since credit card interest rates are significantly higher than a mortgage, this only served to worsen their financial position. It turned out, that in their single-minded pursuit of a mortgage free home, they’d been using most of their cash to pay down the mortgage. This left them relying on credit cards to fund their day to day living. They’d basically been replacing good debt with bad debt.
Credit card interest rates are significantly higher than a mortgage, this only served to worsen their financial position. In addition to being lower cost, good debt is debt that helps improve your financial position overall. Loans to increase your education are typically good debts, since education improves your income earning potential. Home and investment loans are typically good debts, because they increase your assets and are expected to generate income or capital growth.
Bad debts, on the other hand, are high cost, or debts that don’t bring value. Credit card debt and payday loans typically fall into this category. Even car loans can be bad debts, since brand new cars lose their value instantly. If you rely on debt to afford that brand new car, then it’s smart to consider the cheaper second hand option. This way you aren’t stuck with a debt worth significantly more than the asset if you face a financial hurdle. In addition to being lower cost, good debt is debt that helps improve your financial position overall.
Focus on utilising good debt. Avoid, or quickly pay off bad debt. Just following this simple principle will decrease your costs and help bring that debt free goal closer to reality
While we can dream of moving into that no debt position, the reality is that debt is often needed to progress through life.