Good Debt?

There are a lot of people in finance who like to talk about good debt and bad debt, as though debt could either be well behaved or dig lots of holes in your garden. Perhaps debt should be referred to as naughty or nice. I guess in the simplest forms you could categorise them like that, but life’s not that simple so I prefer to refer to debt in a different, more complex way.

Debt is either tax deductible or its not, and debt is used to buy something that will either rise or fall in value.

While you are still awake I’ll tell you about tax deductible debt; it’s anything that can be included in your personal or business tax return (yes, you might need to grab yourself a coffee at this point). The majority of taxpayers would not be able to claim a tax deduction on their credit card or personal loan interest, because the purchase that’s accruing interest hasn’t been for something that earns income. If you use your car for work (that’s at work, not driving to and from the office) and your car has a loan, you will be able to claim a bit of the interest on that loan. Tax deductible debts are also the loans used to purchase investments like shares and property (but not vacant blocks of land). Because the tax deduction allows you to effectively lower the interest you pay, there is not the same urgency to pay off these loans. Thus the ‘good’ debt. [As a side, I’ve never heard from a victim of a rogue geared investment scheme referring to the debt that crippled them as being good in any way.]

When you have purchased something with debt that you can’t claim on your tax (pair of jeans, Blu-ray recorder, cat food, snowboard, etc.) then you want to pay this off as soon as you can. This debt is usually for stuff that falls in value (the coffee you have just finished won’t be worth too much now, and the cat food’s only worth something if it’s been half eaten by Paris Hilton’s dog, you can prove it, and successfully sell it to some idiot on eBay). Bad debt. Naughty debt. Go and sit in the corner.

Things in the non-tax deductible debt category that go up in value are usually only homes (mortgages) and qualifications (FEE HELP). They might not always rise in value but they should be worth more as the years go by. Sort of, kinda, alright good debt. Good because it’s not bad, but I’d never refer to a half million dollar mortgage as good. These debts should still be paid off quickly, but there’s no need to pay off FEE HELP or HECS debt quickly.

Like I said, it’s complicated.

To make it easy to remember, get rid of all the debt that you can’t claim on your tax, especially if the debt was used to buy things that aren’t worth as much anymore. After they’re gone then you can concentrate on paying off that geared share portfolio and investment property.

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