How debt can be a useful financial tool when used sensibly

The common catchcry from hard-up young Australians is that Baby Boomers had it lucky because they were able to buy houses when property was comparatively cheaper.

The fact is, though, it’s never been easy to buy a first home. It’s true that house prices were lower in the 1960s, ‘70s and ‘80s, but it still took a lot of discipline to save a deposit and then pay off a mortgage, especially when mortgage rates hit 17 per cent in the late ‘80s and early ‘90s .

The fact that older Australians managed to do so is testament to the fact that the Baby Boomer generation treated saving and debt very differently to the current generation. In short, if you wanted something, you saved up for it, and if you did borrow for a big item, you paid it off as fast as possible to avoid heavy interest charges.

These days, of course, credit is everywhere. Australia has one of the highest levels of household debt in the world. While mortgages make up most of that debt, Australians also owe around $45 billion on credit cards, with younger Aussies most likely to struggle managing that debt.

But that doesn’t mean that that debt is always a bad thing. In fact, the combination of your financial discipline and judicious use of credit could work in your favour.

Myth busted: Saving is always the smartest thing to do

First, we’ll state what seems like the obvious. If you have a lot of debt, it’s often smarter to use any spare money to pay it off, rather than saving. To know whether this is the right move for you, simply compare the after-tax interest rate you’d earn on your savings against the rate you’d pay on your debt; if the interest rate on your debt is higher, pay it off first.

The importance of paying off debt may seem like a basic point but it’s one some Australians don’t understand, according to Rob Lockhart, a financial educator from Westpac’s Davidson Institute.

“I think where people fall into a trap, particularly with credit cards, is they think they’ll buy it on a credit card, but then they don’t pay it off,” Lockhart says. “And if the credit card has 20 per cent interest and they’re not paying it off, they’re chewing up a lot of money.”

Luckily, most people do know how important it is to pay debts, and instead use debt to their own advantage. Research from the Reserve Bank of Australia shows that most Aussies don’t pay any interest on their credit card bills at all because they pay the full balance before it’s due.

Myth busted: Debt is always dangerous

Lockhart says credit cards can be a great money-management tool – provided they’re used sensibly as he describes below.

“Credit cards are particularly fabulous for timing differences,” he says. “If I know I’m getting some money in a week’s time or a month’s time and I need to spend it now, I can use the credit card. And if I’ve got an interest-free period, as long as that money’s coming in the next month, you might get away with not paying any interest.”

All it takes is a little shuffling of numbers in your budget spreadsheet. “The payments are still coming out of my budget, except what I would be allocating as savings, I’d now put as debt repayments,” he says. “It’s going to cost me a little bit more because I may be paying interest, and it’s going to take me a little bit longer to pay it off, but the difference is, I have the thing I need now.”

Lockhart says this use of debt can work well for retirees as long as they have a regular income, perhaps from the Age Pension or as an income stream from a superannuation fund.

“When you’re over 60, what you’ve got to think about is what are the things I need now, and do I have the income coming in to make those repayments?” Lockhart says. “We’re not getting any younger! It might be a big trip or whatever, but I do need to make sure that I could have saved for it, but I’m just going to take it now. I’ve got that money coming from future income to pay it off.”

Using money borrowed via a credit card to make a purchase can repay you in other ways, providing you’re disciplined about making repayments. Spending a little extra to buy a quality item, for example, may mean that any additional cost you incur in interest repayments is recompensed through the item lasting longer or performing better than a cheaper version.

Likewise, buying in bulk, even on credit, may provide savings that outweigh the interest cost, if you can be certain you will use the items over the long term. And some upfront expenditure, such as for a gym membership that improves your health, may be worth the extra cost in interest if it reduces your healthcare costs down the track.

Over-60s have the edge on debt

Lockhart believes today’s fast-paced society pushes Aussies fall into trouble with debt.

“We’ve got to get instant gratification,” he says. “It’s causing problems because people aren’t thinking enough into the future, putting money aside. And they’re not valuing what they’re getting as much because they’re not putting in the hard yards to get it.”

But that’s not a mindset most older Australians have. Combined with their long experience of saving, they’re generally in a better position to use debt sensibly. “If you think of everything you do with finances throughout your life, the one thing that teaches you about how to handle your money is actually being able to save,” Lockhart says.

Things to know: The information in this publication is general information and factual only. It does not constitute any recommendation or financial product advice. It is an overview only and it should not be considered a comprehensive statement on any matter or relied upon as such. You should consider obtaining your own independent professional advice. 

IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial or legal situation, objectives or needs. That means it’s not financial product or legal advice and shouldn’t be relied upon as if it is. Before making a financial or legal decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services or legal advice.