WHAT happens when good debt goes bad? And can you change bad debt to good?
The best debt: You borrow money to buy something that continues to yield personal or financial benefits - ideally long after you have paid off the debt. And if you borrowed to invest, you might be able to deduct the loan interest.
The worst debt: You borrow to buy a depreciating asset - again, personal or financial. The item or investment is long gone but you are still paying off the loan.
While an RBC survey shows 26 per cent of Canadians are debt-free (vs. 22 per cent a year ago), Statistics Canada reports an increase in household debt (presumably among the remaining 74 per cent) - to 163 per cent of disposable income compared to the previously reported 152 per cent.
With holiday season spending just around the corner, many of us are tempted to spend more than we should - too often running up bad debt.
Major good debt typically includes a home mortgage.
But if you borrow more than you can comfortably afford to pay back, leaving little money for other expenses, or perhaps running up more debt to cover those expenses, then this good debt goes bad.
Student loans are also good debt provided they are indeed paid off promptly once the student enters the workforce.
Investment loans are good debt as long as the borrower can tolerate the personal and financial risk if the investment performs poorly.
If you have investments and a non-deductible loan, it could make sense to cash in the investments to pay off the loan, then borrow to reinvest (but check both transaction and possible income tax costs), turning bad debt into good.
If you have rental, self-employed or other business income, see an advisor about structuring loans to maximize their deductibility.
Making loans within a family to shift income to lower tax can also produce good debt - again, get expert advice.
Mike Grenby is a columnist and independent personal financial advisor; he'll answer questions in this column as space allows but cannot reply personally - email [email protected].
THINGS TO CONSIDER ABOUT DEBT:
- How to maximize the good
- Avoid good debt going bad
- Bad debt can turn into good debt
