Good debt vs bad debt

Not all debt is created equal. Some borrowing leaves you better off even after every interest dollar is counted. Some leaves you paying, for years, for things that stopped mattering long ago. The labels good debt and bad debt are blunt, but the idea underneath them is one of the sharpest tools in finance.

What makes debt good

Good debt buys something that grows in value or lifts your income by more than the debt costs. A sensible home loan can qualify, because the house shelters you for decades and property has historically grown over long periods, though never in a straight line and never guaranteed. HECS HELP usually qualifies, because it is interest free, indexed rather than charged interest, and buys qualifications that tend to raise lifetime earnings. A loan for tools or training that directly increases what you can earn can qualify too.

What makes debt bad

Bad debt buys things that fall in value, at interest rates that make the fall steeper. Cars are the classic case: a new car loses a large slice of its value in the first few years, so borrowing heavily for one means paying interest on an asset that is shrinking underneath you. Consumer debt is worse again: card balances and buy now pay later stacks funding clothes, tech and nights out. The purchase depreciates to zero almost immediately, while the debt sits there at full price, charging rent.

Two loans, ten years later

Set two borrowers side by side, both taking on $20,000 of debt. The first borrows it as a HELP debt for a qualification that lifts their pay, and because HELP is interest free and only indexed, and because the qualification raises what they earn for decades, the debt costs them little and returns a lot. The second borrows $20,000 on cards and personal loans for holidays, clothes and a wardrobe of gadgets, at rates that might average an illustrative 18%. Ten years on, the first borrower has a higher income and a debt that shrank in real terms. The second has a pile of worn out and forgotten things, and if the balance was carried rather than cleared, has paid thousands in interest for the privilege. Same $20,000 borrowed. Opposite outcomes, and the difference was never the amount. It was what the money bought and what it cost to hold.

The grey zone

Real life is messier than two labels. A modest car loan that gets you to an apprenticeship is closer to good debt than a luxury car loan is, even though both cars depreciate. A HELP debt for a course you abandon does little for your income. The labels are a starting point. The real test never changes: after all interest and fees, does this borrowing leave future you better off than not borrowing would have?

Ranking your debts

When you eventually hold more than one debt, the order of attack matters. Pay minimums on everything, then send every spare dollar at the highest rate first, because that is the debt growing fastest. By this logic, HELP debt sits last in the queue: it is the cheapest debt an Australian is ever likely to hold, and the money that could overpay it usually works harder elsewhere.

A misconception about mortgages

Good debt is a description of an outcome, not a guarantee stamped on a product. A home loan is often held up as the classic good debt, and it can be, but it is not automatically good just because it is a mortgage. Borrow more than you can comfortably repay, at the top of a rising market, on a variable rate you have not stress tested, and the same loan can become a burden that follows you for years. The label is earned loan by loan, by the price paid and the value received, never handed out by category.

What this looks like in your life

The bad debt you are most likely to meet first is small and cheerful. A buy now pay later stack across a few apps, a card that creeps up over a summer of eating out, a gadget financed because the monthly figure looked painless. None of it feels like the dramatic debt in the warnings, and that is exactly why it works: it drains quietly. Running the good debt test on even a $200 purchase, will this be worth more or earn me more than I pay for it, builds the instinct you will want when the numbers are $20,000 instead.

The final lesson in this topic follows these debts into your future, where even the good ones use up borrowing power you might want later, and the savings topic shows the other side, money working for you rather than the reverse.