Credit and Debt Management
Understand credit cards, loans, interest rates, debt management strategies, and credit scores.
Understanding Credit
Credit is the ability to borrow money with the promise to repay it later, usually with interest. Credit can be a powerful financial tool when used responsibly, but it can also lead to serious financial difficulty when mismanaged. The most common forms of credit are credit cards, personal loans, home loans (mortgages), and buy now pay later (BNPL) services.
Every form of credit comes with an interest rate -- the cost of borrowing money. Credit card interest rates in Australia typically range from 15% to 22% p.a., making them one of the most expensive forms of borrowing. By contrast, home loans may charge 5-7% p.a. Understanding the true cost of borrowing is essential before taking on any debt.
Types of Credit Compared
| Type | Typical Rate | Secured? | Repayment |
|---|---|---|---|
| Credit Card | 15-22% | No | Revolving (minimum payment) |
| Personal Loan | 7-15% | Usually No | Fixed monthly payments |
| Car Loan | 5-10% | Yes (vehicle) | Fixed monthly payments |
| Home Loan | 5-7% | Yes (property) | Fixed monthly over 25-30 years |
| BNPL | 0% (if on time) | No | Instalments (late fees apply) |
Credit Scores and Credit History
Your credit score is a numerical rating (typically 0-1,200 in Australia) that reflects your creditworthiness. It is calculated by credit reporting agencies such as Equifax, Experian, and illion based on your credit history. A higher score means lenders view you as lower risk, which can lead to better interest rates and loan approvals.
Factors that affect your credit score include: your repayment history (most important), the number of credit applications you have made, your credit utilisation (how much of your available credit you use), any defaults or bankruptcies, and the length of your credit history. Paying bills on time and avoiding unnecessary credit applications are the best ways to maintain a healthy score.
Credit Score Ranges (Equifax)
Debt Management Strategies
When managing multiple debts, two popular strategies are the avalanche method and the snowball method. The avalanche method prioritises paying off the debt with the highest interest rate first, saving you the most money in interest. The snowball method prioritises the smallest debt first, giving quick psychological wins.
Key principles of responsible debt management include: always pay more than the minimum repayment on credit cards, avoid taking on new debt to pay off existing debt (debt spirals), build an emergency fund to avoid relying on credit for unexpected expenses, and distinguish between good debt (investment in assets that appreciate, such as education or property) and bad debt (borrowing for depreciating assets or lifestyle spending).
Avalanche vs Snowball Method
Avalanche Method
Pay highest interest rate first
Saves the most money overall
Best for mathematically optimal results
Snowball Method
Pay smallest balance first
Quick wins boost motivation
Best for building momentum and confidence
Key Vocabulary
Credit Score
A numerical rating (0-1,200 in Australia) that represents your creditworthiness based on your borrowing and repayment history.
Interest Rate
The cost of borrowing money, expressed as a percentage of the amount borrowed per year (p.a.).
Secured Loan
A loan backed by an asset as collateral (e.g. a house or car). The lender can seize the asset if you default.
Minimum Repayment
The smallest amount you must pay on a credit card each month. Paying only this amount results in high total interest costs.
Worked Examples
You have a $3,000 credit card balance at 20% p.a. interest. If you only pay the minimum ($60/month), how much interest accrues in the first month?
Step 1: Convert the annual rate to a monthly rate: 20% / 12 = 1.667% per month.
Step 2: Calculate interest for the first month: $3,000 x 0.01667 = $50.
Step 3: Of the $60 minimum payment, $50 goes to interest and only $10 reduces the balance.
Answer: $50 in interest accrues in the first month. At this rate, it would take over 9 years to pay off the debt.
Using the avalanche method, which debt should you pay first: Card A ($2,000 at 18%), Card B ($500 at 22%), or Loan C ($5,000 at 8%)?
Step 1: List debts by interest rate: Card B (22%), Card A (18%), Loan C (8%).
Step 2: The avalanche method targets the highest rate first.
Answer: Pay Card B (22%) first, while making minimum payments on Card A and Loan C. Then tackle Card A, and finally Loan C.
Explain the difference between good debt and bad debt with examples.
Step 1: Good debt is borrowing for assets that increase in value or generate income. Examples: a HECS-HELP student loan (increases earning potential), a home loan (property may appreciate).
Step 2: Bad debt is borrowing for depreciating assets or consumption. Examples: credit card debt for a holiday, a car loan for a luxury vehicle beyond your means.
Answer: Good debt builds wealth or future earning capacity, while bad debt finances lifestyle spending that does not generate returns.
Knowledge Check
Select the correct answer for each question. Click "Check Answer" to see if you are right.
Question 1
Which type of borrowing typically has the highest interest rate?
Question 2
What is the most important factor affecting your credit score?
Question 3
The debt avalanche method prioritises paying off which debt first?
Question 4
You owe $5,000 on a credit card at 18% p.a. How much interest accrues in one month?
Question 5
Which of the following would be considered "good debt"?
Key Concepts Summary
- ● Credit is the ability to borrow money, and it always comes at a cost (interest).
- ● Credit cards have the highest interest rates (15-22% p.a.) -- always pay more than the minimum.
- ● Your credit score reflects your reliability as a borrower -- protect it by paying on time.
- ● Use the avalanche method (highest rate first) or snowball method (smallest balance first) to manage multiple debts.
- ● Distinguish between good debt (builds wealth) and bad debt (funds consumption).