Good, bad and diabolical

Good, bad and diabolical
August 8, 2010 - SMH
There are different kinds of debt — but if you have the Very Bloody Bad variety, get rid of it.


YOU'VE probably heard about good debt and bad debt. Well, they should rightfully be called All Right Debt and Very Bloody Bad Debt.

The former is usually over assets that generate income and so earn tax deductions. It's "all right" because it potentially builds your wealth. VBBD, by contrast, actually drains your wealth potential.

Advertisement: Story continues belowWe're talking credit cards and personal loans. And yes, even your mortgage - although I'll get to why this is a special category.

With rates up - and probably headed higher yet - it's time to attack VBBD before it eats further into your future prosperity.

Credit cards and personal loans are the worst kind because they have the highest interest rates and are used for depreciating assets - in other words, those that will lose value over time. Or they are for experiences for which you'll have nothing to show afterwards, such as holidays.

Credit cards are priority No. 1. Not only are the rates typically the heftiest but the repayments also are often set so low you'll never pay them off.

A debt of $2000 on a card with a 17.65 per cent rate, a $59 annual fee that you add to the outstanding balance and a 1.5 per cent minimum repayment will in 25 years leave you with a debt of not $2000 but $3242. And you'll have paid almost $12,000 in interest.

Cannex calculates you'll still have debt in 25 years on cards with more than 16 per cent interest, a $24 annual fee and a minimum repayment of 2 per cent or less. This won't happen with a personal loan - repayments are set so you'll clear it in the agreed time. Such discipline can make them a better alternative.

The best way to eradicate credit card debt is to transfer your balance to a card that charges low or no interest for an introductory period and move heaven and earth to knock it off in that time. Don't use the card for any new spending - this is how the banks recoup their apparent generosity. Fresh debt will attract a high interest rate from day one and until you've cleared your entire transferred balance.

So what makes mortgages special VBBD? The fact they are over an asset, which is hopefully appreciating, so with any luck you'll end up paying out less by the end than your property is by then worth.

What's more, as with personal loans, the repayment schedule makes them a form of forced saving that can be a positive.

With - usually - lower rates than credit cards or personal loans, your home loan is the third debt to which you should turn your attention.

But remember that, as probably your biggest debt, your potential savings from early repayment are massive. Pay $100 extra a month on a $250,000, 25-year mortgage at 8 per cent and you'll save $53,000 (and more than three years); manage $500 and it jumps to $155,000 (and more than 10 years).

Beyond simply finding the cash, try these canny strategies.

Trick yourself into it by paying half your monthly repayments fortnightly. It sounds bizarre but because there are 12 months in a year but 26 rather than 24 fortnights, over the year you will make a whole extra - relatively painless - repayment.
Use every dollar twice by keeping and making savings into an offset account attached to the mortgage, so they are netted off your debt. You will save more in mortgage interest than you would make in a deposit account. And the fact that these are only "effective", rather than actual, earnings will mean no tax.
Get the bank to help by switching to a better deal. Even 0.5 percentage points will make a huge difference.

Use the rate rises as your incentive to bust out of debt far faster and a chunk cheaper.