Used appropriately, debt can be a wonderful financial tool that can help to build your wealth, however if used incorrectly its effects can be devastating.
Therefore it’s imperative that households understand and continually assess their debt to avoid financial impairment. Here’s what you should look out for, as well as some positive steps you can take should you need help getting back on track.
Good debt vs. bad debt
Essentially, good debt is money borrowed to buy something that will rise in value, bring in an income and create financial discipline such as borrowing to buy a house. Whereas bad debt is money borrowed to fund everyday expenses like a holiday, or to buy an asset that will generally decrease in value like a car.
However, if repayments on the loan (good or bad) become overwhelming, the level of debt becomes adverse to your initial financial goals and/or living standard.
The warning signs
When it comes to adequately managing your debt, it is critical that you are able to recognise the warning signs. Those associated with bad debt include failing to pay off credit card balances on time or the interest repayments on a personal loan.
Whilst those associated with good debt include falling behind on interest repayments, or the value of the asset falling below the value of the loan.
Borrow within your means
When it comes to borrowing – the most critical component is not how much you owe or how much you can borrow, but how much you can afford to repay.
Start by preparing a comprehensive budget listing all income and expenses whilst allocating a percentage of income towards saving for the future.
Take control of your spending
Using your budget, work out whether you’re in deficit or surplus and act accordingly. If you are in a deficit, look at what expenses you can cut to get back on track. If you’re in surplus look to service existing debts, save for the future and invest.
Make extra repayments
Funnelling extra money into paying debts off early will save you big on interest and free up money to put towards building your wealth. Start with the highest interest rate debts fist such as credit cards, because they are costing you the most.
Once your credit card is paid off in full, focus your efforts on the next highest interest rate loan, for example a car loan.
Minimise your interest
Too many Australian’s are not seizing the opportunity to minimise the interest they pay on their existing loans, and with rates at an all time low – now is the time to do so.
Start by comparing the market for a better rate, negotiate with your bank or talk to a mortgage broker – who will do all the leg work at no cost to you.
Ultimately, if you can borrow within your means, control your spending and minimise bad debts and interest, you are managing debt effectively. However if you find that your debt is becoming unmanageable – reach out to one of our experienced consultants to see how can help you get back on track.