Good debt vs bad debt
Debt used to acquire income-producing assets, where interest is deductible, versus debt funding consumption.
Good debt buys something that produces income or is expected to appreciate — an investment property, shares, or a business. The interest is generally tax deductible, and the asset can outgrow the cost of the loan.
Bad debt funds consumption: credit cards, personal loans for holidays, buy now pay later. The interest is not deductible and the item bought usually falls in value immediately.
Your home loan sits in between. It is not deductible because the home produces no income, but it funds an appreciating asset at a far lower rate than consumer debt.
The same $20,000, two outcomes
Borrowed at 7% to buy income-producing shares, the interest is deductible and the asset may grow. Borrowed at 20% on a credit card for a holiday, nothing is deductible and nothing remains.
The bit people get wrong
Deductibility follows the use of the funds, not the security. Borrowing against your home to buy shares creates deductible interest; borrowing against an investment property for a holiday does not.
Common questions
Should I pay off my mortgage or invest?
Compare the after-tax cost of the debt with the expected after-tax return of the investment. Paying down non-deductible debt is a guaranteed, risk-free return at your loan rate.
Is debt recycling worth considering?
Converting non-deductible home debt into deductible investment debt can be effective, but it adds market risk and requires meticulous record keeping and usually advice.
Which debt should I clear first?
Highest interest rate first, almost always. Credit cards and personal loans before the mortgage, and non-deductible before deductible.