Debt Management Smart Guide

1. Good debt, bad debt

If you've borrowed money then you're in debt. However, debt isn't necessarily a bad thing. We go into debt to buy things we can't swallow in one "gulp", such as a home, and some people use debt with the aim of boosting their investment returns.

As long as you remain in control of your debt - that is, you stay on top of your repayments - debt isn't a problem. But if debt starts to control you, rather than the other way round, you need to take action.

Read more about:

Stressed out? Don't worry, be happy, Judy Adamson, April 5, 2006 - The Sydney Morning Herald: When financial stress affects your health, it's time to take stock of your life.

High taxes share blame for rise in household debt, Annette Sampson, February 5, 2005 - The Sydney Morning Herald: How serious are you about reducing debt?

Debt checklist

Rather than trying to dig yourself out of a debt hole, it's a much better idea to follow some simple rules when talking to lenders so you don't get into trouble in the first place.

Before taking out a loan check:

• The term of the loan.
• The interest rate that will be charged and how often the payments must be made.
• The way the rate is determined - is it variable (the lender can move the rate up and down) or fixed?
• Fees over and above the interest payments, such as monthly "service" fees.
• The actual amount, in dollar terms, that will be paid over the life of the loan. On a house, over 25 years, this will be several times the actual price.
• The type of security required - for example, a mortgage on a house may involve the lender having title over the property.
• Can you repay the loan early? Is there a penalty for early repayment?
• What happens if you experience short-term financial difficulties or are unable to repay the loan?
• Is the contract covered by the Consumer Credit Code?

Prioritise your debt

If you can, make extra repayments on your debts so you build a buffer in case of a rainy day. In doing this, some debts deserve more attention than others.

Make it a priority to pay off "bad debt" first - that is, your borrowings for consumption (clothes, holidays) rather than investment (property, shares). That's because interest on debt such as personal loans and credit card debt isn't tax deductible, whereas the interest on loans for investment purposes can be claimed as an expense.

Pay off this "non-deductible" debt first, starting with the debt that has the highest interest rate.

For most people that means the credit card debt should go first, then the car loan, followed by the mortgage (which is exempt from capital gains tax, though you can't claim your interest payments). Your investment loans come last on the list.

Read more about:

Clean sweep, John Collett, January 31, 2006, The Sydney Morning Herald: The first step towards financial independence is to get your debt under control.