How debt can create wealth

Increased household debt coupled with low interest rates has helped many Australians build wealth in recent times. The key to success however is in ensuring debt is managed well.

For the majority of Australian households, debt is a fact of life and something we need, particularly if we aspire to own our own home – a goal that has long been coined ‘the Australian dream’.

Debt though is only a powerful way to build wealth when it is managed properly.

We look at some of the findings from the latest AMP.NATSEM report – Buy now, pay later: Household debt in Australia, which looks at how good debt can build wealth and how bad debt can diminish it.

How has household debt increased and why?

The AMP.NATSEM report shows the average household debt today is four times what it was in 1988, up from $60,000 to $245,000, while the ratio of debt to disposable income has nearly tripled.

Interestingly, more than 90% of Australian household debt is being spent on building wealth or buying a home to live in, rather than purchasing consumables.

People’s appetite and tolerance for debt is being fuelled by declining interest rates and lower interest repayments.

Are rising debt levels a good or a bad thing?

Debt is considered good when it’s efficient - that is, when it’s working to help you build capital. All debt costs money but bad debt is seen as inefficient because it doesn’t build long-term wealth.

For instance, an example of good debt is an education loan as it should enhance your career prospects whereas an example of a bad debt might be an overseas holiday.

AMP.NATSEM figures show good debt has helped generate considerable wealth for many Australians, but it isn’t going away quickly.

We’ve got a range of calculators that can help you budget and save.

Where do interest rates fit into the picture?

With Australians more heavily indebted today than in years gone by, it’s important to consider the effects, should interest rates rise, and to budget accordingly.

AMP.NATSEM findings show if interest rates rose by 2.5 percentage points:

  • Repayments for households with home loans and ‘typical’ levels of debt would increase from 16% to 23% of income. Annual interest payments would also rise by $6,223 p.a.
  • Repayments for Australia’s most indebted households with mortgages would increase from 42% to at least 58% of income. Annual interest payments would rise by $16,615 p.a.

This is why it’s important to plan ahead and avoid the type of debt that’s primarily used to fund a lifestyle that cannot be sustained.

How can debt be managed well?

There are many ways to make debt work for you and to be smart with your money.

It helps to factor in the impact of interest rate rises and to have a contingency plan around employment changes, including income protection, or if an unforeseen health event prevents you from working.

The AMP.NATSEM report highlights that 25% of Australians are experiencing financial stress, which is why it’s important to be on the front foot and plan ahead.

If you’d like to know more or want assistance

Find a financial adviser who can help you plan ahead, or try our budget calculator.

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© AMP Life Limited. This provides general information and hasn’t taken your circumstances into account. It’s important to consider your particular circumstances before deciding what’s right for you. Although the information is from sources considered reliable, AMP does not guarantee that it is accurate or complete. You should not rely upon it and should seek qualified advice before making any investment decision. Except where liability under any statute cannot be excluded, AMP does not accept any liability (whether under contract, tort or otherwise) for any resulting loss or damage of the reader or any other person.