How to use debt to build wealth

You may have been taught that debt is the dirty word of the financial world. Something to be avoided at all costs. But in reality not all debt is bad. And having debt doesn’t mean you’re in bad financial shape. 

With historically low interest rates likely to be around for some time, there’s never been a better time to look at how you can use debt to build wealth.

Good debt vs. bad debt

Any good financial advisor will tell you, good debt is debt that makes you money, while bad debt is debt that costs you money. Bad debt is also any debt you cannot afford to repay.

Bad debt – debt used to buy goods or services that won’t increase in value or that generate no income. Credit card debt (not paid within the interest free period), loans to fund luxury items or holidays are examples of bad debt. 

Good debt – debt that lets you buy assets that will increase in value or earn you an income. The loan interest is often tax deductible and the income can be used to repay the loan. Buying shares, property and investing in managed funds are all examples of good debt. 

HECS debts are an investment in your future so are included in the good debt column.

Can go either way debt

A car loan can be deemed a bad debt as the car depreciates in value over time. But used wisely to buy a decent car that does the job of transporting you and your family and gets paid down quickly, is one of those necessary bad debts. Just don’t use it to upgrade to a fancy new car every few years just because you can. This is where it may leap into really bad debt territory.

A home loan is almost universally considered a good debt because you’re buying an asset. And let’s face it, for many Australians the Great Aussie Dream of home ownership is almost out of reach, let alone buying your home with a big wad of cash.

Like a car loan, if you borrow too much and can’t comfortably repay your home loan (a home loan repayment shouldn’t use more than a third of your income), you can quickly find yourself in financial trouble. Borrow what you can afford, keep up repayments and you’ll ultimately own a great asset.

Once you know the difference between good and bad debt, you can start making informed decisions to start creating wealth from debt. 

Make your savings work for you, not the bank

Do you have an emergency fund tucked away? A little nest egg for ‘just in case’? First of all, we love that and applaud your dedication. But if it’s just sitting in an ordinary savings account, it’s currently earning little interest. 

Mortgage offset account - by moving your extra money into a savings account linked to your mortgage, you’ll still have access to the funds, but they’ll also be shaving interest and months (maybe even years) from your home loan. 

Mortgage redraw – you pay extra money into your mortgage but can take out (redraw) the money if needed. This money reduces the loan balance and the interest.

Managing your cash flow

A quick and easy way to better manage your cash flow is by reducing your interest payments. And every little bit helps. Whether it’s: 

• paying your mortgage more often (fortnightly vs monthly), 
• increasing the repayment amount, 
• paying all your credit card debt during the interest free period, or;
• putting all your income into a mortgage offset account.

And over the span of twenty or thirty years, those little bits add up to great big money savings for you.

Consolidate your debts

Having lots of smaller debts, especially debt that attracts high interest and/or annual fees, could be costing you more than just dollars. You may want to consider taking out a personal loan or increase your mortgage and have just the one debt to service. Increasing your mortgage will save interest as mortgage interest rates are much lower than other types of debt. And your home loan repayments may increase by just a small amount or maybe not at all. 

It’s important when making these decisions to speak to your financial institution lender or financial advisor, to find the best ways to consolidate your debt to suit your personal circumstances.

Using lump sums of money 

Perhaps you’ve received a bonus, an inheritance or a redundancy payment. Use this lump sum to pay down bad debt, such as your credit cards, car or personal loans. Don’t just dump the money into a savings account. If you’ve paid down your smaller debts, or have none other than your mortgage, consider putting it against your mortgage or investing.

Borrowing to invest - using debt to build wealth

When you’ve paid down or consolidated your bad debts, maybe it’s time to consider creating some good debt to build your wealth. Known as ‘gearing’, if you invest wisely in assets that increase in value, the income from the investment will pay off the debt. In Australia, many people invest in property and shares.

Borrowing to invest can be a savvy way to build wealth over time. This is because it allows you to purchase more investments than would be otherwise possible.

Ideally your investment will increase in value over time, and with capital growth (such as an increase in property value) and income generated (for example, rent) you’ll be able to pay back your debt and enjoy the benefits of tax deductible interest charges. 

Of course, there is always a risk that your investments may decrease in value, so it’s important to have considered the risks.

A savvy investor always wants to speak to a financial advisor first. Should you be positively or negatively gearing your new investment property? And if you do buy an investment property, we’ve got you covered with our ultimate guide to investment property tax deductions.

However you decide to use debt to build wealth, we want to help you be better off. Whether you want help saving a little over a long time, or you’ve got a nice big chunk of change you want to invest, we’re just a phone call away. 

Interested in learning more?

Click here to book a discovery session. Already a Kelly+Partners client? Get in contact with your Client Director to get started today.

This offer for Private Wealth Services is not available to clients of BMF as at 31 December 2016.

DISCLAIMER

Kelly Partners Private Wealth (Wholesale) Pty Ltd is a corporate authorised representative of Kelly Partners Private Wealth Pty ltd (AFSL: 516704, ABN 14 629 559 860). Any general advice provided has been prepared without taking into account your objectives, financial situation or needs. Before acting on the advice, you should consider the appropriateness of the advice with regard to your objectives, financial situation and needs.

Kelly Partners Private Wealth Sydney Pty Ltd is a corporate authorised representative of Madison Financial Group Pty Ltd (AFSL: 246679, ABN: 36 002 459 001)