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Debt is a four letter word
18 August 2016

Debt is one person’s liability, but another person’s asset. Paul Krugman

It was once said that “Debt” was the free man’s slavery. Understanding the difference between good and bad debt could help you make better financial decisions.

Debt is generally considered to be good if it helps you purchase wealth-building resources such as assets that are probably going to give you an income and/or grow in value. Good debt could also be tax deductible. An example is borrowing money to purchase an investment property, which may appreciate in value over time. In the case of an investment property, the owner may be able to use the rental income from the property to help pay off the investment home loan. Investors may also be entitled to a tax deduction known as negative gearing if the loan interest on the repayments and other expenses exceed the rental income earned on the property.

Debt may be considered bad for your wealth if it is used to buy assets that will depreciate, does not earn you any money and are not tax deductible. Using a credit card or a personal loan to pay for things like luxury goods and holidays is also considered an example of taking on bad debt. Can bad debt ever be good? Arguably bad debt can help you manage your finances. If you are disciplined and pay off your credit card at the end of the month, you have used the credit card as positive way to manage your cash flow.

Credit card debt becomes damaging when you buy luxury goods that you cannot afford and begin to live beyond your means. This can result in high monthly interest payments accruing over time, which may become increasingly difficult to pay off. 

Should you consider a debt consolidation loan? If you are struggling to manage your debts, it may sound like a good idea to pay someone to fix your credit problems and roll all your loans into one loan. At this point a financial planner can help you navigate a way out of the quagmire. Debt consolidation can get you even deeper into debt by letting you borrow more. If the consolidation loan simply increases your overall level of debt, you are making your financial problems worse. There are other possibilities to explore before consolidating your debts. Consider why the debt was acquired and what type of debt it is. If living beyond your means is the culprit, and it usually is, a consolidation loan maybe a snake in the snakes and ladders game of finance. Not only will you have to repay the consolidation loan, you will have to continue to meet the repayments to further credit card or other consumer debt you rack up afterwards. A consolidation loan will only help if you totally understand the long term significance of having such a loan and if it reduces our debt. But it is not the quick fix that providers make it out to be.

Some other solutions to consider are talking to your credit provider. Come to an arrangement with them if it is possible. Another is to switch home loans to save money on your mortgage or even selling your home if you are struggling with mortgage repayments. You may even end up with money left over to repay other debts. Most importantly, get financial advice all the way especially if it is not costing extra to get that advice, which is one of the advantages of a Hudson membership. 

It is not surprising that getting into debt happens. The average Australian household debt has quadrupled over the last three decades, according to a new report, with the average household debt now sitting at almost $250,000. How is it in our day and age that we are increasingly in debt? You may be surprised to learn the part you play in creating an economy.  When we take out loans, new money is created. As people borrow more, more new money comes into the economy. This gives the impression the economy is doing well. If financial problems are caused by people having too much debt, how can the solution be for people to take on more debt? It does not make sense. This is one of the twists in an economy.

Conversely, the more people save via repaying debt and consequently do not spend their incomes, the less consumption occurs in the economy. This is likewise a dangerous predicament for an economy.  Don’t let the economy work you, it is up to you to get it to work for you. No matter where you are financially, get informed, get advice and take positive action.





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