What′s the difference between good and bad debt?

A recent question on my News Corp Gen Y column is whether all debt is bad and if not, what the difference is between good and bad debt.

It?s definitely true that not all debt is bad. After all, even most of those with a “good job” – such as the type of job Joe Hockey has in mind for those living in Sydney – will need to take on a fair amount of debt to buy a house. And for those interested, this is what housing affordability looks like in New South Wales at the moment. So is that home loan debt bad? Well, no – provided you didn?t pay far too much for the property, or get into far too much debt than you can afford.

On the other hand that credit card debt that you may have gradually accumulated over a number of year, at a current average interest rate of 17 percent, is probably bad debt. Particularly if you accumulated it by spending too much money on random stuff that really isn?t important.

 

So what is the difference between good and bad debt? There isn?t a single answer, but here are three questions to ask yourself before signing up for any new loans.

Is the debt a tax deduction?

Investment loans, such as mortgages on an investment property or margin loans for share investments, can be a good form of debt. That said many Gen Y would appear not to have investment debt, with an Officeworks survey finding that 59% of 18-24 year olds and 45% of 25-34 year olds only claim tax deductions that don?t need a receipt. What a waste! Why give more money to the government, via extra tax, than you need to?

Is it for a worthwhile investment?

Not all investment debt is good debt; irrespective of tax deduction it?s only a good debt if it?s being put towards a good investment that will grow in value. So look beyond the deduction to the quality and value of what you?re buying before taking the plunge. After all, investment debt can still be bad if you have paid way too much for the asset in the first place or if you have overextended yourself in the process.

 

Will the debt improve your life?

I don?t mean the way that a new pair of shoes will improve your life but rather the way that a new trade or tertiary qualification will improve your life. Getting extra qualifications or extra practical work experience can supercharge your career and help you earn significantly more over your life. The debt taken on to achieve that can be a good investment.

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