Debt often receives a bad rap. Rising interest rates over the past year have done little for its reputation, however when debt is part of a clear financial planning strategy, it can contribute positively to achieving lifestyle goals and personal wealth.
If you, or those close to you have debt, you’d be forgiven for second guessing yourself when it comes to whether or not you’re managing your debt effectively. In this article we explore what you need to know about good and bad debt and overview common debt milestones for the early, middle and pre-retirement stages of life.
Good debt, bad debt is a fairly common financial planning concept which in broad terms focuses on using debt for building wealth, while paying down bad debt that creates expense.
Examples of good debt include using borrowed money to buy shares, invest in managed funds and for purchasing income producing and appreciating assets that pay dividends, generate rent or create an income stream that can boost your wealth. Bad debt, the likes of which is created by credit cards and personal loans, can be useful and convenient for achieving short term goals but very high interest rates, fees and charges mean they can be costly if not tightly controlled.
The early years – understanding debt
People in their 20’s begin earning and with that comes spending. And, usually plenty of it! Unfortunately, lack of financial knowledge, self-discipline and the convenience of cashless purchasing, can result in over-spending and a reliance on credit cards, buy now pay later services and personal loans to fund purchases and their busy social lives.
If you choose to share the ‘Good Debt, Bad Debt’ concept with the young people in your life, it probably won’t prevent them from using credit cards or taking out personal loans, it may provide value financial education. They will understand that bad debt, should be short term, paid off quickly and completely. Similarly, if they understand the value of good debt, they can begin building their financial resources and wealth early.
Of course, credit card debt isn’t limited to young adults, it transcends all age groups and ease of access can facilitate a temptation to run up debt on multiple credit cards.
The Middle years – using debt to accumulate wealth
Home loans also fall into the bad debt category and this is because private homes generally don’t generate income and the interest on the loan is not tax deductible.
Typically those in their early 30’s through 50’s are the most common accumulators of debt. These are the middle years of life or perhaps they’re better described as the ‘debt years’ when your home loan is a 30-year commitment that can account for 30 to 40 percent of your household income.
During that time your circumstances can change considerably, so it’s important to have a loan that remains relevant for your needs. This will include a competitive interest rate and facilities that include options for redrawing funds or a loan offset account that can provide flexibility for accessing funds in an emergency or for making the most of wealth generation opportunities.
It should also be noted, during the ‘debt years’ it’s wise to consider personal risk insurance that can cover your expenses including your home loan repayments, should you pass away become ill or have an accident that prevents you from earning.
By the time you make your 40’s, you should have consolidated or repaid any minor debts and knocked a substantial amount off your home loan.
You may have built-up surplus equity in your property that could provide wealth creation opportunities. These could include tax effectively using that equity in the form of an investment loan to purchase shares, units in managed funds or property. Over time, the bad debt will reduce and the good debt will fund further investments.
Whether you use your surplus cash to reduce your debt or contribute it to your super fund depends on your circumstances. There’s value in both options and we’d be happy to advise you on the appropriate actions for making the most of either opportunity.
Pre-retirement years – clearing debt
During your 50s, a number of things happen all at once. Your kids finish school along and with that, your school fee obligation finishes too, and they begin earning for themselves (and may even move out!)
It’s also the inheritance era. Money and assets left to you by parents and older relatives can provide additional wealth.
With less expenses, you’ll probably feel like you have more surplus cash than you’ve had in a very long time. And it will provide you with options - finish off any remaining debt (while deciding whether or not to keep your loan facility open) invest in shares or property, contribute to super or perhaps you could enjoy some well-earned discretionary spending to celebrate becoming debt-free.
These are of course generalised debt milestones. Using debt for good and making the most of lifestyle and personal wealth creation opportunities requires professional advice in context of your bigger financial plan.
This is an important point and the reason why we coordinate closely with lenders alongside our clients so that decision making about debt aligns with our clients’ big picture core financial goals.
To find out more about unlocking the good debt potential in your financial planning, please contact Matt Lane or Alec Winter on 07 3720 1299 or email admin@wealthfundamentals.com.au.
Lane Moses Pty Ltd ABN 56 092 186 117 trading as Wealth Fundamentals and its advisers are Authorised Representatives of Fortnum Private Wealth Ltd ABN 54 139 889 535 AFSL 357306.
The information (including taxation) contained within this document does not consider your personal circumstances and is of a general nature only - unless otherwise stated. Wealth Fundamentals strongly suggests that you should not act on it without first obtaining professional advice specific to your circumstances. This information is based on our understanding of legislation at the time of writing. Such legislation may be subject to change. This publication cannot be reproduced in any form without the express written consent of the author.