You need to stay away from toxic debt

(5 minute read – toxic debt)

Let’s talk about debt.

You see, debt can generally be categorised into two types: Plain old, mildly harmful regular debt, and toxic debt. I don’t believe there is such a thing as a ‘good’ debt. As an accountant, I don’t want to call the opposite of less harmful debt ‘bad debt’ – which basically means money that people owe you which is never going to get paid.

No dear reader, in this article, we’re going to take specific aim at toxic debt.

But first, let’s talk a bit about debt in general

Why take on debt?

For one reason.

We simply don’t have the money to buy the things we want to buy at the time we want (which is usually RIGHT NOW).

Let’s take houses for example. Most of us wouldn’t be able to afford a house with cash. That’s why we take out house loans. We borrow money from the bank so that we can buy things we want at the time we want them. And then we spend the rest of our working lives paying off that debt. Not ideal, but it’s the most common way into home ownership.

But what about everything else? Is it worth getting into debt over other things that we want?

Most debt is toxic debt.

I’m not going to hold back here. Most debt IS toxic.

You see, most debt arrangements come with interest attached to them – which is to say, the longer you take to pay off that debt, the more money you will be paying the lender. Interest rates can range from the relatively benign (like the one on your mortgage) to plain daylight robbery (like the ones on credit cards).

Often its small amounts of debt that incur the highest amount of interest. Hence why small amounts of debt are the worst possible type of debt there is as they slowly accummulate and their interest balloons over time.

How does debt become toxic?

Easy. It often starts with a credit card (it usually does). A credit card gives you a false sense of financial security. A safety cash net you can fall back on when you’re short on money. It gives you money to buy groceries. It also helps you buy that fancy new phone or pair of shoes you’ve always wanted.

Except that it’s not really helping.

We live in a society, where we’re always being told to buy more and spend more. It’s this consumerist culture that drives mad spending. And debt is simply the gateway drug that allows us to indulge ourselves on things we wouldn’t normally be able to buy. So it traps us. When that 28.99% interest rate comes crashing down on us, we wonder where we went wrong.

What debt is toxic debt?

It’s very easy to tell what is toxic debt. They have two defining characteristics:

1. Not interest-free
2. Does not help you make more money

Based on these two characteristics, all consumer debt. Now, you may (rightly) point out that most credit cards offer interest-free periods of up to two months and providers like Afterpay/Humm/Oxipay allow you to pay in interest free instalments. And yes, you are a responsible user who always, ALWAYS pays up on time.

But what if you slip up?

All it takes is one bad month. One missed paycheck. One medical emergency. And then the credit card company you so loved and trusted will be onto you like a pack of hounds. You’ll suddenly start getting penalties piled up on your ‘interest-free’ instalments. The illusion of wealth created by debt will shatter and break.

How can we avoid toxic debt?

It can be tricky.

Everywhere we go, we’re frequently pushed new and innovative ways to purchase items we don’t need with money we don’t have. If you’ve managed to live this long without taking any debt – you’re a real champion! If you are a business owner, this is even more challenging as in some cases, debt can be used to help grow your business. But it can easily drag your business down as well.

The simplest piece of advice I can give you is to not give in.

If you don’t have the money to buy something now. You shouldn’t be borrowing money to buy it.

Resist the urge! No matter what the credit card company says, nor how sexy their personal loan ads are, DON’T DO IT. This applies to pretty much any retail purchase.

You want new shoes? Don’t have the money? Don’t buy it.

You want a new boardgame? Don’t have the money? Don’t buy it.

You want a new laptop? Don’t have the money? Don’t buy it.

90% of the time it really is that easy. But what about the other 10%?

Make debt work for you instead (the other 10%)

We’ve established that debt is bad for you. Basically what you’re doing is that you’re working hard to make the credit card company rich. It’s worse than working for a toxic boss (because at least you can leave your job if you don’t like it). You can’t leave toxic debt, it remains on your credit history like a permanent stain, refusing to budge until you pay it off.

So how can we make debt work for us instead?

Now, before we talk more about this – please take this advice with a grain of salt. I’m approaching this from a business perspective and the idea is that:

“If you can make more money from the debt than you would spend in paying off its interest, then you’re making the debt work for you,”

For example:

Sara borrows $11,800 from the government at an interest rate of 3% per annum to purchase a new delivery van for her baking business. She hopes that the new van will help increase her sales by 50%! This will help cover the interest expense of borrowing the money.

Of course this is easier said than done. And it’s easy to fall into the trap of taking on debt to ‘grow the business’ when all you’re doing is digging yourself further into debt with no return.

Wanting to borrow for your business? You need to read this article first!

Make sure you do your homework first, have a plan and never ever let debt control you.

But what about taking on debt for investing?

You mean like, taking a loan out on a rental property? If you are guaranteed a rental income that covers both your interest and principal repayments – go for it. Otherwise, don’t do it.

Oh, and never, ever take out a loan to buy stocks/shares. Ever. And don’t even think about borrowing to buy crypto.

Identify toxic debt and avoid it

It’s impossible to go through life without taking on any form of debt. The important message here is to be aware of what toxic debt looks like and avoid it. As much as you can, make debt work for you instead of you working for it.