You’ve probably heard the saying: “You need money to make money”. Unless you have a very wealthy family or have inherited a fortune, you will need to get into debt at some point or points of your life. After all, it would take a very long time for a young person to save the total purchase price of a car, let alone their first home.
So we can probably all agree that all not debt is bad.
Let’s look at different types of debt.
Home loan payments
Mortgage debt is a so-called “good debt” because it is helping you to acquire an asset, which will grow in value over the years, as well as giving you a roof over your head. The interest payments are not “money down the drain” so to speak. After all, by paying rent, you are enriching your landlord, but by paying off a mortgage you are enriching yourself.
What can you afford?
For most people, their home loan is the biggest and most important debt they will ever have. It is all very well to fall in love with a particular house or apartment, but, can you afford it? The expert opinion is that your total monthly debt, including mortgage repayments, car loan and credit card payments, should not exceed 1/3rd of your total monthly income. If it does, you are likely to get into financial strife sooner rather than later. Get financial advice from your mortgage broker or accountant.
Advantages of having a mortgage
Apart from giving you a roof over your head and acquiring a valuable asset, if you have a good credit record with your bank, ie you make all your payments on time, it will be easier for you to borrow money in the future for an investment property, for example, or for a bigger and better car.
We couldn’t imagine life without them, yet, they are the most common type of “bad debt” since they are usually used for consumer spending, where there is little to show at the end – nothing of any commercial or saleable value, in any event. Yet they make our life easy and practical. After all, who can always have enough cash in their wallet when they go shopping or go out with friends?
Benefits of credit cards
- They are convenient to use and can be used almost everywhere and at all times including overseas;
- Many are linked to reward programs like Frequent Flyers;
- If you lose a credit card it can be cancelled and a new one issued, unlike losing cash, which a bank will not replace;
- If you are unfortunate enough to lose your card or have it stolen and used by an unauthorized party, your credit card provider will compensate you for the loss. In fact, the merchant where the card was used will wear the loss;
Disadvantages of credit cards
- The interest rate is very high, usually 18.5%-21.5% per annum;
- There is a temptation only to pay the minimum amount due each month rather than the full amount;
- There is a temptation to buy more than you actually need because it does not really feel like spending money;
- There is the temptation to increase your credit limit beyond what you can comfortably pay in a month because credit card companies regularly invite you to increase your credit limit; and
- There is the danger of having too many credit cards because it is so easy to obtain them, and thereby getting into levels of debt which you cannot afford to pay in full each month.
Using your credit card wisely
- Always pay off the full amount each month;
- Only have one credit card, or at most two;
- Keep the limit down to what you can comfortably afford to pay in full each month; and
- Whatever you do, don’t pay your mortgage off with your credit card.