How being in debt can help you become financially secure

Rates and Fees verified correct on October 21st, 2016

Debt is scary, but controlling debt is empowering, according to Money School's founder Lacey Filipich

Lacey Filipich

Founder and director of Money School

There are two types of debt – good and bad. One helps create wealth, the other hinders it.

Filipich founded the Money School advisory service after realising that many of her contemporaries weren't confident about their finances. "When I was in my mid 20’s, the investments I had started making when I was 19 years old began to pay me a passive income. I could see there would come a time in the next 10 years when I wouldn’t have to work to cover my living expenses," she told "I founded Money School to pass on my knowledge."

Debt and wealth creation: Finding a balance

Lacey notes that there are two types of debt; good and bad. Good debt helps create wealth; bad debt hinders it.

"Good debt, which is used to purchase assets, helps you create wealth when the asset grows by more than the cost of borrowing," she says. "The debt in this case helps you leverage what you’ve got to get better assets, which in turn increases your returns. It’s a win-win situation for you and the lender." Note that in this context, assets are anything that can help you make money, not some strict banker's definition. Investing in property is one clear example of a "good debt" strategy.

"Bad debt, which is used to buy liabilities, hinders you as it means you pay more for items which don’t create wealth," Filipich says. "In this case only the lender wins, as the borrower is paying for items that decline in value with their future earnings, therefore paying more than they should for little or no return. Not only is it ineffective use of the borrower’s money, it also restricts their ability to borrow ‘good’ debt, and subsequently their ability to purchase assets reduces."

typing on the keyboard

The illusion of avoiding debt

So when does it make sense to take on debt? Filipich argues that there are three criteria that are crucial:

  1. The debt is used to purchase an asset (something that either makes money or increases in value).
  2. You can afford to make the relevant payments on any loan.
  3. You're not worried about taking on the debt.

"I would comfortably take on debt that I knew I could service using conservative estimates of interest rates and my income, and that didn’t cause me to lose sleep at night," Filipich said.

That's the key for me – whatever I do financially, I need to be able to relax about it or I don't do it

"I also use a credit card, which means I do take on debt that doesn’t meet criteria number one. I do it because of the security credit cards offer against fraud as well as their convenience. My limit is low enough that I know I can always pay it off in full each month so it never costs me any interest."

Finding the right way to pay down your debt
There's no single specific debt reduction strategy that works for everyone. The best way to pay off debt will differ depending on you and your circumstances.

Using the example of $20,000 worth of debt, Filipich outlines how she would work to pay it off.

"If it was 'bad' debt, I would make it a priority to pay it off as quickly as possible. I’d go without some luxury items in my budget – holidays, dinners out, new clothes – to have more cash to direct towards that debt."

"If it was 'good' debt, I’d probably pay it off at slightly above the minimum repayment rate, using the asset’s income (such as rent and dividends) to cover the costs."

Debt consolidation strategies

If you have multiple 'bad' debts, then it may be helpful to consider debt consolidation strategies.

"Debt consolidation is not essential or useful for everyone, but it is good for those people who are losing sleep because they are overwhelmed with several debt repayments and who are not sure how to prioritise them," Filipich says.

"If you decide to pursue debt consolidation, make sure you understand the full cost of the terms versus what you would pay if you simply handled the individual debts yourself, as it may cost you more in total to consolidate." Remember that your options include both debt consolidation loans and 0% balance transfers for credit cards.

"Don’t allow yourself to be seduced by the simplicity of one monthly payment until you’ve done that maths," Filipich says. "When you’ve worked it out, you may decide that extra cost is worth it to ease your mind."

The struggle with debt

If you are feeling your debt affecting your finances, Filpich’s number one tip is simple: "Stop adding to it immediately! Cut up your credit cards, or freeze them in a glass of water if needed. Do whatever it takes to stop spending, then put all your energy into paying down the debt as quickly as you can. If you’re struggling, it’s because you’ve borrowed too much – keep that in mind before you start borrowing again."

Debt doesn’t have to weigh you down, whether it’s financially or emotionally. Making a positive move towards developing your financial literacy can help you get back in control and stay there for years to come.

Elizabeth Barry

Elizabeth is a senior writer for specialising in personal finance. She enjoys reading PDSs so you don’t have to.

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