Good debt, bad debt

According to this story a number of New Zealanders are planning to put some of their household bills on the plastic later this year.

Using your credit card for everyday spending can be a smart move if you always pay your balance in full each month (because you get interest-free days on your spending). Credit card payments can also be more convenient because you can make them online or over the phone.

But paying on the plastic is not such a good idea if you aren’t able to clear your credit card debt each month.

That way you are effectively borrowing to pay for your living costs, and paying more than you need to through interest charges. 

Before you borrow money, you need to consider whether it will be good debt or bad debt. Good debt is value building debt. For example borrowing money to purchase an asset that is likely to increase or hold its value such as a mortgage for a house, or borrowing money for an education that will enhance your earning power.

Bad debt is value losing debt. Borrowing money to pay for things that reduce in value or have no financial value after you've paid for them. Living costs fall into this category and should ideally be paid from your income or short-term savings.

If you really need to borrow money to pay for groceries or your power bill, you should probably get help straightaway from a budget adviser.

Paying back the money you’ve borrowed can seem overwhelming. But a smart strategy to tackle debt will help you pay it back faster.

Get rid of your high interest debts first, such as credit cards. Next, try to increase your loan repayments to clear the rest of your debt quicker. Check with your lender that paying off your debt faster won't result in penalty payments.

Use our Credit card calculator to find out how much you’ve really paid for that overseas holiday. For example if you have a $4000 credit card debt and pay 19.95% interest, at monthly payments of $100 it will take five years and seven months to pay it off. You’ll pay $2,633 in interest, and that holiday just cost you $6,633 – not so cheap after all.

Once you’ve worked out how much debt you have, use Sorted’s Budget calculator to set yourself a budget. See if you can create a surplus that you can use to increase your debt repayments.