Generally speaking, good debt is debt that is tax deductible, while bad debt is generally not. Ensuring the balance is tipped in your favour by reducing borrowings with non-deductible interest is one of the most important elements of a wealth-building strategy.
Interest incurred on credit cards and borrowings to buy a home, car or other discretionary items are not deductible against your taxes, so it is important to pay down these debts as quickly as possible.
Transferring credit card balances to low-interest rate alternatives and shopping around for cheaper home loans will help.
Currently, there are about 70 credit cards offering balance transfer deals from interest-free periods of up to nine months, to 1 per cent for a year and lower ongoing rates than what you might be paying now. This strategy can cut hundreds, perhaps thousands of dollars in interest and free up savings to pay other bills or even produce income in an income-bearing investment.1
Alternatively, refinancing your mortgage to absorb and eliminate a large debt or taking out a personal loan to do the same, would reduce the amount of interest paid in the short term.
Likewise, interest charged can be minimised by switching to a cheaper mortgage, restructuring your home loan into a line of credit, opting for a redraw facility into which your wages are paid or offsetting your borrowing with any savings you may have.
If using a mortgage offset account, a borrower with say a $20,000 savings account could offset by that figure the balance of a mortgage that will be charged interest. So in this case a home loan of $200,000 will only attract interest on $180,000.
Only disciplined borrowers should consider lines of credit, which basically operate like huge overdrafts with property as collateral. The risk is you may end up exhausting most of the equity in your property over time if you spend more than the total of the wages being paid into the loan.2
Redraw facilities on home loans are less risky as the funds allowed to be ‘withdrawn’ are limited to the amount you have paid off the mortgage over and above the minimum required.
Finally, homeowners with investments can ‘recycle’ their debt to pay out non-deductible loans quicker, eg borrow to invest and use the investment earnings and tax savings to repay non-deductible debt more quickly.
Call us today to discuss which interest-rate reduction plan will help you cut back bad debts so you have more to invest.
1 Info Choice, 2013, viewed 22 March 2013, http://www.infochoice.com.au/banking/credit-card/balance-transfer-credit-cards/#
2 Consumer credit legal centre NSW, 2013, viewed 22 March 2013, http://cclcnsw.org.au/fact-sheets/getting-a-loan/line-of-credit-loans-and-home-loans-with-redraw/