Insight

A (very sensible) introduction to debt

9th Apr, 06:55

Kate Iselin

Unless you were born with a silver spoon in your mouth and a trust fund ready to be deployed on your eighteenth birthday, there's a pretty high chance that you will be in debt at some point in your life.

You're not alone, either: according to recent statistics released by ING, almost two-thirds of working Australians are in debt, and one third of us made 'paying off debt' one of our goals for 2020. Finder tells us that there are precisely 14,652,549 credit cards in Australia as of January 2020, and according to the ATO there are three million of us with HELP debt accrued from pursuing higher education.

These numbers might sound intimidating, but there's something reassuring we can take away from this: being in debt is really common. So let's make this clear.

There's nothing wrong with being in debt.

As we know, a huge majority of Australians are in debt. Heck, even our government is in debt. The stigma around being in debt can make it unfairly embarrassing and uncomfortable to talk about, but the reality is that for most of us, debt is a part of life.

The way that banks, debt collectors, and the government talk about debt can be really dehumanising. And the negative and pessimistic language that the media uses around debt can make it seem like getting into any amount of debt is a financial death sentence. This isn't the case.

Unlike our parents and their parents before them, we are growing up in a world where the odds are not in our favour when it comes to money. Wage growth is stagnant, and the cost of living is rising. Your grandparents' advice to keep a few dollars in your pocket for a rainy day is well-meaning, but no longer realistic.

So – in a world that seems to be in increasing amounts of financial strife every day – how can we manage debt? How can we avoid getting into it, and how can we pay off what we have? And are those quick-and-easy loans advertised on TV too good to be true, or what? We’re going to find out.

Can we avoid debt?

The short answer is that unless you win the lottery, you probably won't be able to get through your entire life debt-free. But this doesn't mean you should rush out and spend like there's no tomorrow, either. While we may not be able to avoid getting into debt, we can be selective about the type of debt we have, and we can weigh up our options carefully when it comes to borrowing money.

Let’s talk about it in terms of good debt versus bad debt.

Good debt is the kind of debt you accrue when you borrow money for something that's useful, practical, and will benefit your life in the long-term.

Money you borrow to buy a house or start a business is good debt, so is money you borrow to go to university. When you look at your life ten years from now, you might still be paying off that debt, but you'll also be reaping the rewards of your home, your business, or your degree.

While these kinds of purchases might be among the more expensive you'll make – meaning you get into more debt to make them – they're also generally worth it.

Bad debt is the kind of debt you get into when you use money you don't have to buy something you don't need, like a trip overseas or the hottest car on the market when last year's model will do.

These things are great fun to have, but they're not worth getting into debt over. Unless you're in a time of need and you have to put the groceries on the credit card or borrow money from a friend for rent – and we've all been there – then try to avoid getting into unnecessary debt over smaller items.

What's the best way to borrow money?

There are countless ways to get into debt, so let's look at some now. From the best, to the worst...

Bank loans

It's never exactly fun to borrow a huge amount of money, but if you're going to do it you might as well do it the safest way possible. I'd love to tell you exactly which bank offers you the best bang for your proverbial buck, but this information changes so rapidly that a good deal today may not seem like a good deal next week.

Before taking out a loan from a bank, shop around and compare multiple offers, and negotiate the terms of the loan if you can. Also, make sure you read the fine print of any contract you sign so you're completely aware of your rights and responsibilities when paying the loan back.

HELP debt

If you decide to go to university, the good old Australian Government makes it pretty easy for you by offering you a loan of up to AUD$100,000 (and possibly more, depending on what you study) to fund your education.

There are fair criticisms to be made about the current HELP loan structure, but unless you can afford to pay for a degree out of pocket then it's our best option right now. A HELP loan is quick and easy to apply for, and you only need to start paying it back once you're earning over a set amount.

Credit cards

Credit cards are easy to get and easy to misuse. Just take it from twenty-one year-old me, who racked up a few thousand dollars worth of debt and is still paying it off now.

There are good arguments for credit cards: they can come in handy in an emergency, and if you spend a little each month and pay it off promptly it can help you maintain a good credit score.

But credit cards also usually charge a high interest rate, meaning that you'll pay more over time for what you spend. By all means get yourself a credit card: but make sure you understand the terms and conditions, and keep it tucked away safe somewhere if you don't trust yourself to use it responsibly.

Borrowing from a friend or family member

When you need money quickly and don't want to make it official with a bank, borrowing from your parents or your best mate can seem like a great idea. But if you borrow from someone you know, make sure you set realistic goals about paying them back and tell them honestly if you can't afford a repayment. Money has soured – and even ended – many relationships, and losing a friend or hurting a parent isn't worth a few hundred dollars, especially if it's money you don't urgently need.

Payday loans

We've all seen the ads on TV promising loans of a few thousand dollars, deposited into your bank account within twenty-four hours. Small personal loans – or 'payday loans' – are often advertised as an option for people with low credit scores who are unable to get a credit card or apply for a loan with a bank.

They might deliver the money you need, but the interest fee on these small loans can be astronomically high and the repayment plan can be short, leaving you stuck with even more owing if you can't pay the amount back within a certain period of time.

Finder found that a loan of AUD$1,500, for example, can come with a set-up fee of 20 per cent, plus a monthly fee of around two to four per cent. If you repay that loan over approximately two months, you could be up for almost AUD$2,000 in the end - assuming you don’t miss any instalments.

It’s easy to imagine how someone desperate for money could get caught in a vicious cycle of owing more and more as fees pile up. Unless you have absolutely no other options, I would not recommend these loans. If something seems too good to be true, it often is.

Getting into debt isn’t always as easy to do as we imagine, and it’s harder still to do it the right way. The decisions we make now will affect our financial future for potentially the next few decades, so however you choose to borrow money: do your research, make informed decisions, and whatever you do, don’t forget to read the fine print.