UniSuper Advice Private Client Adviser, Alexia Jackson, spoke to us about some important things to consider when managing your borrowings.
Is there such a thing as ‘good’ debt?
‘Good’ debt helps buy assets that have the potential to increase in value and/or provide an income.
Investment debt can be tax deductible, which means it may allow the holder a reduction in taxable income. It should be emphasised, however, that when borrowing to invest, taxation is only one of the matters that must be considered—the goal is creating wealth wisely.
When borrowing to invest, it’s important to be cautious around risk: shares may have volatility, and rental properties can be vacant, so that may cause pressure on personal cash flow.
A home loan, although generally not tax deductible, isn’t necessarily ‘bad debt’, as it’s a tax-free investment and most Australians have their home as a major part of their total wealth.
Student debt can also be considered a form of ‘good’ debt, helping to improve possibilities for a career with potentially higher salary earnings.
What about ”not so good” debt?
Examples of this may include non-deductible debt, and borrowings used to buy goods that are likely to depreciate in value and/or provide no income.
Examples may also include borrowing for items which are used 100% for personal use, like cars, holidays, or house contents.
Credit card debt, personal loans, or store cards that generally accrue interest can be forms of ‘bad debt’— if they’re not creating you any income or financial reward.
If you borrow to buy land—where the area has little or no potential for capital growth—remember that land doesn’t provide income. If there’s no capital growth, what’s the real purpose of this investment?
Are there rules of thumb when considering appropriate levels of investment debt?
There are a few questions that ought to be considered before taking out investment debt, such as:
- What cash flow is needed to support the repayments?
- How would interest rate increases affect that cash flow requirement?
- What is the liquidity of the underlying assets?
- How would periods of negative investment returns affect the investment?
Are there any useful debt management strategies?
Generally, you’d pay down non-deductible debts with higher interest rates first, such as credit cards or personal loans.
Consider transferring high-interest rate debt to lower interest-rate facilities.
Debt strategies may benefit from an annual review. You have to be disciplined about reviewing your strategy, looking at all relevant factors.
Look at cash flow. Has your income changed? Has your tax rate changed? How is your investment performing? And are there any adjustments that you need to make to maximise that strategy?
Also importantly, a debt strategy—for personal or investment purposes—may benefit from appropriate wealth protection, where personal insurance can protect income you’re expecting to need for paying off your loans.
Set up a budget and get your cash flow under control
Our online budgeting tool can help you work out your income and expenses, giving you a clearer picture of your financial situation.
You can also speak to a qualified financial adviser for more specific help.