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Debt is not always bad news

Patricia Babalis avatar
Patricia Babalis
- 3 min read
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Banking and real estate experts banded together last week to alert consumers to the risks associated with excessive debt levels.

Commonwealth Bank chief Ian Narev led the charge warning Australians against the dangers of taking on too much debt as economic conditions were far from stable.  Real estate spruiker, John McGrath also jumped into the debate, cautioning that low interest rates could create a real estate bubble. 

Yet investment commentator Paul Clitheroe, founding director of financial planning firm ipac and chairman of the Australia Government Financial Literacy Board, says that no matter what the state of play in the economy might be, some debt is actually helpful.

“Debts like our mortgages are what I call ‘happily necessary’ debt, and I’m comfortable with this type of debt because it’s helping us buy into a worthwhile asset – a home,” said Clitheroe.

Clitheroe is also comfortable with what he labels ‘effective’ debt.

“This is money borrowed to purchase investments such as quality shares, or a well-located rental property,” he said.

“As the interest charge is generally tax deductible, the cost of financing an investment can be significantly reduced depending on your personal tax rate, however it’s still worth thinking about how you would cope: if interest rates started to rise; investment markets took another tumble; or you lost your job.”

According to Clitheroe, there is also ‘sadly necessary’ debt, which involves borrowing money for a car to get to work, while he advises that ‘disastrous’ debts’ should be avoided at all costs.

“A classic example is a large credit card balance resulting from purchases like a big TV that you didn’t need, or a personal loan taken out a few years ago to pay off a vacation that’s long since been forgotten,” said Clitheroe.

“These sorts of debt, rather than home loans, tend to be the chief culprit for financial misery.”

If you are battling ballooning debts, Alex Parsons, CEO of RateCity, says recognising that help is available is a start.

“A sensible first step is to speak to your creditors before skipping a bill or credit card repayment altogether,” said Parsons.

“You may be able to negotiate a manageable repayment plan – one that fits your budget. Avoid taking on fresh debt to pay off what you already owe as this could be the start of an escalating debt spiral.”

For a short-term repayment reprieve, he said, consider refinancing into a lower rate home loan, credit card or personal loan to ease the repayment pressure.

“RateCity’s database shows that by switching from the average mortgage rate into one of the lowest advertised rates you could free up around $200 per month on a $300,000 mortgage.”

It’s not a long term solution, of course, as rates may ultimately increase. For further advice talk to your lender or a free financial counsellor.

Disclaimer

This article is over two years old, last updated on August 18, 2013. While RateCity makes best efforts to update every important article regularly, the information in this piece may not be as relevant as it once was. Alternatively, please consider checking recent home loans articles.

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