Smart vs dumb: What to do about your debt

Debt can be a lifesaver. Borrowing money from banks, finance companies, friends or family can help you get ahead in life and give you possibilities.  But it can also stop you doing what you really want to and be a major cause of stress.

Sometimes, the lines between the two are blurred. Or, debt can be all of these things at different stages in your life.  

Whilst a comfortably off Kiwi on a good salary may look down on, “Friday night takeaway loans”, someone who just needs to get through to pay day and pay for the kids’ school trip could see a short-term loan as a lifesaver.   

Think of debt as a tool that can be used or misused. When Sorted interviewed ordinary Kiwis about their debt for Money Week, it heard people say “it gets me by”, or comments such as, “I would rather get a loan and get me a flat rather than be homeless”.  It also heard the words: “It stresses me out” from plenty of ordinary Kiwis.  

Debt can be dumb and smart Man goes shopping with his credit card

As a nation, we’ve come to view having debt as a normal part of life.  But there are different types of debt.  Some debt is good or “smart”,  other debt is bad or “dumb”. 

  • Smart debt: Smart debt is borrowing to invest, or to improve your financial situation. Borrowing can be a smart way to buy a home, for example.  Your home loan helps you pay off an appreciating asset. Good debt is also student or business loans. Your student debt should give you a better paying job. A business should ramp up your earning power. 
  • Dumb debt: Bad/dumb debt is borrowing to consume. It’s non-essentials you buy on your credit card or with other loans or assets that go down in value. Calling it “dumb” is a bit harsh because most Kiwis want to have a few nice things.  That’s fine, providing you realise that things bought on credit cost you more than the same item bought for cash.   

 Why smart can be dumb and dumb smart

Buying-your-first-car-costs-to-budget-forJust to muddy the waters further, sometimes dumb debt can be smart and vice versa.  In certain circumstances, a car loan may be smart debt if that car is absolutely and truthfully essential to get you to work to make money.  It’s dumb if you’re upgrading because you just want a better car, or have convinced yourself you “need” it, but could get to work in the existing wheels. 

If dumb debt increases your well-being, then it might just be smart to take out a loan. Maybe you’re borrowing to buy a treadmill that you will actually use to get fit. Or, to pay for alternative therapies that are going to make you healthier.   But don’t use “well-being” or “work” as a blanket excuse for everything you buy, or you’re just fooling yourself.  

Think about whether it's smart to borrow money for a flash home redesign

Smart debt can be dumb, if it’s not really getting you ahead financially.   Consider this scenario.  You have a good home in Ellerslie, or Island Bay or Linwood.  But you dream of a new kitchen, or bathroom or extension.  You tell yourself you’re “investing” and, therefore, it’s smart debt. It’s rare that extensions and expensive designer bathrooms truthfully pay for themselves.  Homeowners are motivated by their ideal of a perfect home, not the numbers on a spreadsheet.  A litmus test is hard-core investors, who rarely sink money into this kind of renovation.   

Another common move, is to extend the mortgage to pay down credit cards or upgrade the car.  It’s shifting dumb debt onto the mortgage, and hiding it from yourself. Of course, paying a lower interest rate can make sense. But not if you’re paying it over 25/30 years because you’ll pay more interest in the long run.  It is possible to ring fence that part of the mortgage, so it’s paid off over three or five years, which can be sensible.  Even so, if the original debt was spent on non-essentials then a portion of the home loan is dumb debt no matter what you tell yourself it means to you.  

Compare home loans

 Boozing away the student loan 

Student drinks a jug of beer at the bar

 Student loans are another type of smart debt that can be misused. There are two issues here: 

  1. Will your degree earn you more? Is the degree/study you’re doing actually going to earn you more than not having the qualification? This is not just a question for arts degrees.  Universities make places available, according to the demand from students to enrol, not the number of jobs available. Therefore, courses such as law and architecture, which you’d expect to lead to a high paying job, are producing more graduates than are needed.
  2. Not all student loan money is spent on essentials. Some of that money is spent on alcohol and partying, or frittered away on non-essentials, that could be anything from top-of-the-range technology to takeaways.  It happens. When asked for Money Week what they wished they’d known before they took out a student loan Victoria several made points related to alcohol. One said: “don’t spend your course related costs on alcohol”. Another chipped in: “don’t drink too much”. Yet another said: “always think about budgeting – luxuries can wait”.  

How to make a budget you can stick to

 You can, of course, make your “smart debt” extra smart.  If, for example, you’re paying a mortgage on your house, can you make some money out of it? Could you let a room in your house through Airbnb or to a flatmate or foreign student? Could you use your car to drive for Uber on the weekends or rent it to others through a peer-to-peer car rental scheme?  Or could you simply share expenses with a colleague in your ride to work? 

Even then smart debt can be smarter and dumb debt less dumb if you shop around for better bank products that charge less in fees and interest.

Compare home loans

Compare credit cards

Enjoy reading this article?

Sign up to receive more news like this straight to your inbox.

By subscribing you agree to the Canstar Privacy Policy

Share this article