Why do we want Bad Debt made Good?
Good debt is recognised when tax-effective funding of investments and effective wealth accumulation occurs.
Making bad debt good, is to move the debt from assets that are not income producing to assets that are – and the interest on the debt becoming tax deductible (warning – it must be correctly managed).
What is ‘bad debt’?
It is any debt that has to be repaid from after-tax money: it is said to be ‘bad’ because the interest cost of the debt is not tax-deductible and so capital is reduced or recurring income absorbed, in paying the interest incurred, in a non-tax beneficial way.
Whilst some may consider the term ‘good debt’ to be an oxymoron, structuring debt so that the interest cost is tax deductible, results in better debt management – at least from a servicing cost point of view.
As is evidenced in the following Table, paying interest from after-tax income hurts: the real costs especially hurt! Consider the following table, showing the real cost of paying $1,000 interest at different levels of marginal tax rates:
| Tax rate (including Medicare Levy: 2%) | 21% | 34.5% | 39% | 47% |
|---|---|---|---|---|
| Real $ cost of $1,000 interest (‘bad debt’) | 1,266 | 1,527 | 1,639 | 1,887 |
So, what is the cost of ‘good debt’?
Consider a strategy that we refer to as debt recycling. Such a strategy, when based on home loan accounts, will considerably reduce the ‘after-tax’ interest cost on your home loan borrowing(s). What does the above Table look like if the interest cost is reduced by virtue of it being tax-deductible?
| Tax rate (including Medicare Levy: 2%) | 21% | 34.5% | 39% | 47% |
|---|---|---|---|---|
| Real cost of $1,000 interest (‘good debt’) | 790 | 655 | 610 | 530 |
Comparing the two Tables, you see that the real interest cost is between $476 and $1,357 per annum less for each $1,000 of nominal interest paid in a ‘good debt’ situation over a ‘bad’ one.
Need help to better manage your debt?
Can you be more financially efficient?
Do you want to reduce the real cost of borrowing?
Would you benefit from a diversified investment portfolio?
The advisers at Continuum Financial Planners Pty Ltd are experienced at helping clients make bad debt, good through strategic management of their affairs, reducing real interest costs: this strategy facilitates repaying their loan faster while building an investment portfolio that is focused on capital growth, tax effective income and tax deductible borrowing expenses. If you, your family or friends could benefit from such a strategy, please call us (on 07-34213456) and arrange a meeting with one of our experienced financial planners. Alternatively, use the Contact Us page – and however you contact us, request our financial health check questionnaire: it could be enlightening.
This article, originally posted in April 2013, has been updated occasionally, most recently in March 2023.
