Are you working to pay down your debt? Do you know which debt is likely to cause you the most pain and which debt is ‘okay’ or even ‘good’? As we head into the new financial year, firmly putting FY21 behind us (and let’s face it, it really had its challenges!), it’s time to take stock of where you are financially.
Turns out a lot of people think debt is debt – and because debt per se can cause stress, therefore all debt is a terrible thing. But as we’ll discuss, not all debt is created equally. Of course to live debt-free (often touted as a life goal to strive towards), sounds lovely. However, there are certain circumstances where incurring a level of debt, might work in your favour. Let’s look more closely.
Over the next two blog posts, we’re looking at debt – what’s good bad and indifferent. Our thinking was to rank debt as ‘bad’, ‘okay’ and ‘good’ according to its likelihood of being productive vs being non-productive and when we talk productive, we’re talking about it produces or builds your asset base.
This post will start with the bad stuff.
Bad debt produces nothing at the end of the day except perhaps more debt and greater stress levels. One of the things that should forewarn you as to whether a debt is okay or not is the interest rate that goes with it.
Interest rates rarely fall below 12% and often sit as high as 20+%. Store cards or finance deal cards or even those buy now, pay later online shopping apps might let you have whatever they’re selling now, offer interest-free periods and delayed payments. However, if you ever miss a payment or can’t afford your payments when they’re due, you’re likely to incur significant fees or interest accrued above 10%. The only way to use a credit/store card, etc is as a transactional means of paying and pay it off without fail by the due date.
Personal loans including payday loans
(‘Easy’ short term loans to, say, pay to fix your plumbing until you get paid) also have interest rates around 10% or higher. Often people having trouble paying their credit card debt seek out personal loans to consolidate their debt. And certainly paying 10% instead of 20% interest can seem appealing. However, often in that situation, people still have access to their credit cards and so end up with a personal loan and then, because they’ve not changed their habits, they also end up with newly incurred credit card debt.
Or, these types of loans also get taken out to fund holidays or small renovations. But when the purchase is over, it’s not done anything to really grow your asset base.
The way to avoid really bad debt is to avoid spending money you don’t have.
Certainly, this kind of debt is ‘less bad’ than credit cards or personal loans but they’re often quite expensive to fund and their interest rates often sit around 5-8%. Yes, you’re buying something with a level of resale value. But it’s not really an asset per se. Why? Assets appreciate. Vehicles (except for a rare few) do not. In fact, the second you drive your new car off the lot, it depreciates by about 10% (yes, really). If you use your car for business or work, you might be able to claim a tax deduction (with appropriate records) and that might make it work out a little better for you.
However, easy access to car financing, often means that customers up-level their purchase and buy the next model or two up because it seems like they can afford it. Plus the car industry encourages you to buy a new car every 3-5 years (especially if your car is on lease) because it ‘makes sense’ (to them). In essence, if you buy into that way of thinking, you’re basically renting a car for life.
To avoid getting stuck with higher than necessary debt on cars, buy only what you need and take into account the cost of running, insuring, etc your car prior to purchasing.
And that’s where seeking personal financial advice can help. If you’d like to talk to us about your personal finances as part of looking after your tax affairs, we’d be delighted to talk. You can call us on 02 6023 1700 or drop us a note via the form below.