By Viola Lailee – Debt is something to be avoided at all costs, but not all
debt is bad. Some types of debt can help you build wealth, secure better
financial opportunities, and improve your quality of life. The key is knowing
the difference between good debt and bad debt—and how to manage both wisely.
This guide explains what separates good debt from bad debt, provides
real-world examples, and offers strategies to make debt work for you rather
than against you.
What is Good Debt?
Good debt is money borrowed for investments or expenses that
have the potential to increase in value or generate long-term financial
benefits. It helps you build assets, improve your earning potential, or create
financial stability.
Common Types of Good Debt
1. Home Loans (Mortgages)
Buying a home is one of the most common examples of good
debt. Property values tend to increase over time, meaning a mortgage allows you
to build equity while avoiding rising rental costs.
Example: If you buy a home for $700,000 with a
mortgage, and in 10 years it’s worth $900,000, you’ve gained $200,000 in
equity—all while making repayments on an asset that is increasing in value.
2. Student Loans (HELP/HECS Debt)
Education is an investment in your future earning potential.
Tertiary qualifications can lead to higher salaries, better job stability, and
increased career opportunities.
Australia’s Higher Education Loan Program (HELP) allows
students to defer tuition payments and repay them gradually through the tax
system once their income exceeds a set threshold ($51,550 in 2024-25). Since
the debt is indexed to inflation rather than accumulating interest, it’s one of
the least harmful forms of borrowing.
Example: A university degree in finance, healthcare, or IT
can boost lifetime earnings by hundreds of thousands of dollars, making HELP
debt a worthwhile investment.
3. Business Loans
If used wisely, borrowing money to start or grow a business
can generate significant returns. Business loans help
finance inventory, equipment, or expansion, allowing business owners to
increase revenue.
Example: A café owner borrows $50,000 to upgrade
kitchen equipment, which improves efficiency and boosts profits. Over time, the
increased revenue offsets the loan, making it a smart investment.
4. Investment Loans
Borrowing to invest in
shares, managed funds, or property can be considered good debt if the potential
returns outweigh the cost of borrowing.
Example: If you take out a margin loan to invest
in high-dividend stocks and the returns exceed the interest costs, you can
generate passive income while building wealth. However, investment loans carry
risk, so financial advice is essential.
What is Bad Debt?
Bad debt is money borrowed for depreciating assets or
non-essential expenses that don’t generate long-term financial benefits. It
often comes with high interest rates and can trap borrowers in a cycle of
repayments.
Common Types of Bad Debt
1. Credit Card Debt
Credit cards can be useful when managed responsibly, but
carrying a balance leads to high interest rates (typically 18-22%), making it
difficult to repay.
Example: If you have a $5,000 balance on a card
with 20% interest and only make minimum repayments, you could end up paying
over $10,000 in total.
How to Avoid It:
- Pay off your balance in full each month.
- Use a low-interest credit card or consider a debit card
for everyday spending. - If you’re struggling, a balance transfer card can help
consolidate debt at a lower rate.
2. Payday Loans and Short-Term Loans
Payday loans charge extremely high fees (up to 48% annual
interest), making them one of the most dangerous types of debt. Many borrowers
take out additional loans to cover previous ones, leading to a debt spiral.
Example: Borrowing $500 from a payday lender
could result in repaying over $1,000 within a few months.
How to Avoid It:
- If you need emergency cash, consider no-interest loans
(NILs) from community programs instead. - Build an emergency fund to cover unexpected expenses.
3. Car Loans (for Non-Essential Vehicles)
A car loan isn’t always bad, but financing an expensive
vehicle you don’t need can hurt your financial health. Cars lose value quickly,
meaning you’re paying interest on a depreciating asset.
Example: Buying a $60,000 SUV on finance when a
$25,000 car would serve the same purpose means paying thousands more in
interest on a rapidly depreciating asset.
How to Avoid It:
- Buy a car that fits your needs, not just your lifestyle
aspirations. - Consider a second-hand vehicle to avoid steep
depreciation. - If you must finance, opt for low-interest car loans rather
than dealership finance deals.
4. Buy Now, Pay Later (BNPL) Debt
Services like Afterpay, ZipPay, and Klarna can encourage
overspending. While they don’t charge interest, late fees add up quickly, and
missed payments can impact credit scores.
Example: Splitting $1,200 worth of clothing into
instalments may seem manageable, but it can snowball into multiple BNPL debts,
creating financial strain.
How to Avoid It:
- Use BNPL only for essential purchases.
- Stick to a budget to avoid impulse spending.
- If struggling with multiple BNPL payments, prioritise
paying them off quickly.
Key Differences Between Good Debt and Bad Debt
|
Factor |
Good Debt |
Bad Debt |
|
Purpose |
Builds wealth or increases earning potential |
Spent on depreciating assets or non-essential expenses |
|
Financial Benefit |
Can generate returns (equity, income, education) |
Often results in long-term financial strain |
|
Interest Rates |
Lower rates, often tax-deductible |
High interest rates, compounding quickly |
|
Examples |
Home loans, education loans, business loans |
Credit cards, payday loans, unnecessary car loans |
How to Use Debt Wisely
Even good debt can become bad debt if mismanaged. Here’s how
to ensure debt works for you, not against you:
1. Borrow Only What You Can Afford
Lenders may approve you for more than you actually need. Use
a loan calculator to determine what you can realistically repay.
2. Prioritise Paying Off Bad Debt First
High-interest debts like credit cards should be repaid
before focusing on lower-interest loans. The avalanche method (paying off
highest-interest debt first) is often the most effective strategy.
3. Use Debt for Investments, Not Lifestyle Upgrades
A mortgage, education, or business loan can improve
financial stability, whereas borrowing for designer clothes, gadgets, or luxury
cars can lead to financial stress.
4. Keep an Emergency Fund
Having 3-6 months’ worth of expenses saved can prevent the
need for high-interest borrowing in emergencies.
5. Review Your Debt Regularly
Check your debts and interest rates every few months to see
if refinancing, consolidating, or extra repayments could save you money.
Final Thoughts
Debt itself isn’t the enemy—it’s how you use it that
matters. Good debt can help you achieve long-term financial success, while bad
debt can drag you into financial hardship. The key is intentional
borrowing—using credit as a tool to build wealth and financial stability rather
than funding unnecessary spending. By understanding the difference between good
and bad debt, you can make smarter financial decisions and set yourself up for
a more secure future.