Good debt helps you to build wealth or increases your prospects to build wealth, while bad debt costs you money without improving your financial position.
Good debt is often used to help build long-term wealth and makes financial sense.
Examples of good debt include a home loan (providing you didn’t pay too much for the property and can afford to pay off the loan), or a student loan, which allows you to gain qualifications that are an investment in your future career.
One of the smartest ways to use debt can be borrowing to invest in an asset—such as property or shares—which can generate income and grow in value, while the interest charged on the debt is tax deductible.
Examples of bad debt include money you borrow through credit cards and personal loans to pay for day-to-day expenses, holidays or an asset—such as a car—that tends to decrease in value.
Some may argue that even a loan for your home can be considered bad debt when compared to a loan for an investment property. This is because, while your home is likely to increase in value, it will generally not generate an income and the loan interest charges are not tax deductible. On the flip side, when you sell your home, it will not be subject to the capital gains tax imposed on an investment.
Making the most of good debt
When it comes to making the most of good debt, a debt recycling strategy has the potential to help. Debt recycling can be a high risk strategy—and it doesn’t suit everyone—that allows you to use good debt to repay bad debt more quickly.
Good debt can be used to buy assets, such as an investment property, that have the potential to grow in value and generate an income which can be used to help repay your bad debt. However, even good debt comes with risks, such as an inability to repay it.
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It’s important to consider your particular circumstances and read the relevant Product Disclosure Statement or Terms and Conditions before deciding what’s right for you. This information hasn’t taken your circumstances into account.
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