For most people it would be almost impossible to purchase a house or investment property without borrowing money.
Once you borrow the money it is important to learn to manage the debt as efficiently as possible. Borrowed money should only be used by purchasing assets that grow in value over time, these are called appreciating assets.
Ideally the asset should produce an income, give you tax deductions to help you repay the loan over time. The type of debt you use could help you become wealthy or it could mark the beginning of your down fall!
Debt comes into two forms: Good Debt and Bad Debt. It is also referred to as Efficient Debt and Inefficient Debt.
The table below highlights the main characteristics of debt:
GOOD DEBT||BAD DEBT
|Typical monthly loan repayments paid by you 10% to 15% ||Typical monthly loan repayments paid by you 100%
|Tax Deductible||Non Tax Deductible
|Fully Depreciable||Non Depreciable
|Rental Income||No Rental Income
|Tax Rebate||No Tax Rebate
|Paid From Your Gross Wages||Paid From Your Net Wages
|Working Smarter Not Harder||Working Harder Not Smarter |
Understanding the “Bad” and “Good” debt concept is very important as our society has been conditioned into being great consumers of credit, many of us are very much entrenched in the clutches of bad debt (in other words consumer debt) debt used to finance consumption is fundamentally bad debt:
- Motor Vehicle Loans
- Home Loans (your home will grow over time however, the interest and expenses are not tax deductible)
- Furniture Credit
- Credit Cards
- Clothes Credit
- Entertainment Credit
- Restaurants Credit
- Holidays Credit
Bad Debt: Is expensive, carries high interest rates and is unproductive as it does not produce income. The accumulation of bad debt diminishes your disposable income hence, actually limits your borrowing power for a home or investment property loan (for example, if you have a credit card with a limit of $10 000 your disposable income required to service the card will diminish your property borrowing power by at least $50 000). See How Much Can I Borrow calculator.
Good Debt: Has a financial purpose. It is used to purchase income producing assets that will enhance your financial position.
- Investment Property
- Share Portfolio
These investments are income producing and the borrowing costs and expenses may also be tax deductible.