Many people think of debt as a curse. You're on a merry-go-round of owing money you don't have, and it never seems to stop. However, debt itself isn't necessarily bad. In fact it's necessary. It's bad debt that's bad!
According to the Australian Bureau of Statistics, over the last 18 years, the level of household debt has grown twice as fast as the value of household assets, as the ratio of household debt to assets doubled from 9 percent to 19 percent.
Debt, says financial advisor Jason Andrew, of the ANZ-owned RI Advice, is created when a sum of money (or assets) are loaned to another person with the expectation of a repayment.
"By doing so the debtor uses future purchasing power in the present before it has actually been earned," he says.
Good debt/bad debt
Debt is usually broken down into good and bad debt, but AMP financial planner Dianne Charman goes further with a third category: necessary debt.
"Bad debt refers to large credit card debt, which a person is struggling to pay off," she says.
"Necessary debt is debt that most of us need to have such as a home loan, while good debt is tax deductible debt, which includes loans for income producing investments, such as real estate or shares."
Getting out of debt
Being debt-free at some point in your life, according to the experts, can be done and it's definitely something worth aiming for.
"The general rule of thumb is to pay off bad debt like credit cards first as they usually have the highest interest rates," Charman says.
"If left to spiral out of control, they can cost a person thousands of dollars in interest over many years."
Andrew says that the first thing is to actually have a goal of getting out of debt.
"It might sound obvious, but it's surprising how many people want to get out of bad debt, but don't have a plan and then find themselves in the same situation at the end of every month," he asserts.
Have a goal
One way to start the whole process, Andrew says, is to share your debt-reduction goal with someone.
"Research by the Dominican University of California shows that people who wrote down their goals, shared this information with a friend, and sent weekly updates to that friend were on average 33 percent more successful in accomplishing their stated goals than those who merely formulated goals," he says.
Andrew advises people to aim for goals including "consolidating your debts [including credit card debt] to a lower interest loan; having your salary paid into a mortgage offset account; creating a budget that allows you to increase your payments; and changing your repayments to fortnightly or weekly."
Paying off bad debt
The quickest way for people to get into good debt, Charman says, "is to pay off their bad debt as quickly as possible, and reduce their necessary debt to a comfortable level."
She offers three simple steps for paying off bad debt:
Target credit card debt first. "Make more than the minimum repayments each month."
Consolidate credit card debt. "Roll all the debt in to one low interest-bearing card to save interest. Make more than the minimum payments each month to make any inroads."
Target car loans and personal loans next. "People can cut their interest costs on these types of loans by making additional payments. Making extra payments is not always advised for fixed rate loans, as penalties may apply."
When you've reigned in your bad debt, it's time to "consider borrowing to buy income producing investments, such as property or shares that are expected to grow in value over the long term," Charman says.
"This type of good debt can also be more tax efficient as interest repayments on loans to buy an investment property or shares is generally tax deductible."