Doctor’s Guide to Good Debt and Bad Debt

November 26th, 2013

It is a common thought that we need to avoid debt, or pay off any debt we have as fast as possible. That is good, solid, but conservative advice.  Why conservative? Because you may be able to grow your financial assets faster by using what we call “good” debt. Let’s explain this:

Good Debts vs Bad Debts

 From a financial planning perspective, you would like to have no debt, but if you do have debt, you really want to ensure that the interest you pay is tax deductible. Tax deductible interests (interest on loans for shares, rental properties, and other income producing assets) are good debts. Interests that you pay on your home loan or personal credit cards or on personal loans are “bad” debts, because you cannot claim these interests as tax deductions.

Most people have a home loan and personal credit cards, and the interest on credit cards is much higher than for your home mortgage. That is why financial planners recommend that you use whatever surplus income you have each week to first pay off your credit cards, and then once you have done this you can start to make extra repayments towards your home loan. If your home loan has an interest rate of 6%, then you effectively earn 6% for every dollar you pay off your home loan.

Here’s where debt may be good for you:

If you feel comfortable investing in shares and you expect a 10% return for the year, you could withdraw an amount from your home loan (if you have a redraw facility) and invest this in shares. Your share investment may make a 10% return for the year (dividends received and capital growth), your interest cost is 6%, and this leaves you with a 4% gain for the year. So if you invested $100,000 this way, you would make an extra $4,000 per year after interest costs. Sounds good, doesn’t it?

There are always risks with any investment and please don’t take this article as advice to invest – this is something that you need to talk to one of our qualified financial planners about. The point of this article is to educate you about the opportunities that you should at least consider to grow your wealth.

Very Important: You need the right type of loan:

For years we’ve all seen the TV ads recommending “equity” loans – loans that we can redraw against if we need access to funds. If you want to invest, unless you’ve fully paid off your house an equity loan is the WRONG loan to use.

You need to use a “split” loan – a loan that has an overall facility limit but is broken up into 2 different portions, each with their own monthly statement. The first split is usually for non-tax deductible debt like your home loan and funds redrawn for private use (eg. if you use some funds for a holiday).

The second split is for investing. All of the interest for this second split is tax deductible. If you want to repay any debt with surplus income, you can simply make payments against the first split and reducing the balance, but at the same time seeing you are not paying off any tax deductible debt from the second split, you keep higher tax deductions for interest from the second split.

We can help you!

MEDIQ Financial Services specialises in loans structuring for doctors to ensure your wealth is maximised and your tax is minimised. Contact us today so we can help you review your loans to ensure you are maximising the opportunity available to you.