All the latest news, facts and tips from the team at Pioneer Credit Connect

Nov 18

Good Interest vs. Bad Interest.

by Matthew Ikin
Interest blog covers3

You probably see and hear the word ‘interest’ or ‘interest rates’ every day, whether you’re aware of it or not. Financial products talking about interest rates are everywhere; the sides of buses, billboards in your suburb, or in your everyday banking app.

Often, it may feel more comfortable thinking about physical money when it comes to finances, namely due to its ability to invoke ‘delight’ in us as people. Meanwhile, interest rates are in fact one of the most impactful ‘things;’ to be aware of when it comes to your finances; including savings, investments and credit. In some cases, interest will make you money, while in others, it will cost you (if not cautious, may cost you LOTS more than the principal amount you may borrow). Good vs Bad, Right vs Wrong, Up vs Down. What is good interest, and what is bad interest?

Good interest

What is good interest? This is interest that helps support and positive financial outcome. Sounds a little dry, doesn’t it? The main thing to remember is that good interest helps make you more money. Or, it’s interest that is applied to a credit product that has the capacity to put you in a stronger position, like a mortgage or business loan (always erring on the side of caution when borrowing).

Good, compounding interest is where the most gains are to be had, so here are a few financial products and methods to harness the world of good interest!

Savings accounts

Let’s kick things off with the simplest and most common type of good interest. The classic savings account.

A savings account is one of those things that you’ve probably had your entire adult life, and possibly since you were a primary schooler – remember Dollarmites? Being comfortable with your savings is important to provide stability and comfort. Whether your savings account is small or large, you’ll be accruing good interest. Your bank will be paying you back a percentage of your savings for banking with them. Straight forward, right!

The bank then has the option to use your money to put towards their financial interest and in return, they will compound your account with interest – they’ll pay interest on the interest they already paid you; winner.

Pioneer tip: Most everyday savings accounts have similar features, however the rate each bank offers might differ from one to the other. It’s OK to look online and compare a few choices in the market to find the option that’s right for you today; keep an eye out for special introductory rates!

Term deposits

Term deposits are one of the most popular forms of investment in Australia due to their ability to help you grow your savings whilst also getting access to higher interest rates. Similar to a savings account, a term deposit is a cash investment held at a financial institution where you agree to deposit a certain amount of money each period for an agreed length of time. In return for agreeing to consistently deposit funds to an account, the bank will reward you with a higher interest rate than a regular savings account as they are able to put yours, and other customers savings, towards their own investments for a set period of time. When you deposit the money each period, the funds are typically not accessible for the length of the term deposit which can range from 1 month to 5 years; in most cases, you will get to decide the term. This is considered as ‘good interest’ as the investment you make it compounding extra money on top of the funds you already have deposited.

Offset accounts

A mortgage offset account can be one of the best ways to help you reduce the amount of interest you have to pay on your home loan. While you may have thought that the term ‘good interest’ only applies to interest that the bank pays you, it can also be applied to ways that help you save; because hey, at the end of the day, the outcome is more money in your pocket.

An offset account is a savings account linked to your home loan that allows you to reduce the amount of interest you pay by temporarily reducing the balance of your mortgage. When you put money into your offset account, the bank will reduce this amount from the total you owe when calculating your interest. Here’s an example to help explain what we mean. Say you have $300,000 left to pay on your home loan, and you have $10,000 in your offset account, instead of having to pay interest on the remaining balance of the loan ($300,000), the interest is calculated on the $290,000 as your offset account has ‘offset’ the interest. Over the life of the loan, these savings in interest can add up to thousands of dollars, which is why we have added  mortgages with offset accounts to the ‘good interest’ hall of fame!

But be warned...

In Australia, the ATO regards interest you earn as a form of income. This means that the more interest you earn, the more tax you will have to pay. This is OK. The tax you pay is only a percentage of your income, so more often than not, the interest you earn will still put you in a better financial position than if you never received it at all.

Not so good interest

Being charged interest or credit or lending can have its perks in helping you meet you immediate desires; like purchasing a home (setting yourself up for the future) or upgrading your car. Consider that if getting a loan for a newer car means you’re spending less on maintenance and repairs, then the interest paid is worthwhile for the benefit of owning a reliable car.

Interest can also be ‘not so good’ for your wallet. A simple way to think of this interest is as one that costs you more money than it should when taking into account the value or benefits that you gain. These are typically due to higher rates and being associated with helping to satisfy purchasing ‘wants’ and helping cover expenses in times of ‘desperation’.

Credit cards

Credit cards are one of the kingpins of the ‘not so good interest’ world as they hook you in with little to no interest, then when you start spending, begin to charge you. Often looked upon as short-term solutions, credit cards typically have interest rates around the 20% mark, and whilst they can act as exactly that: ‘a short-term solution’, the interest can start to become very expensive over the long term if you fail to pay your balance fast enough, especially when there are more cost-effective alternatives in the market.

The most important thing to consider with credit cards is “why do I need a credit card?” and are there better alternatives? If the allure is that you really want to buy something cool and don’t have the cash; do not use your credit card. Simply wait until you’ve saved enough money. If the need arises due to large medical bills, or you need to urgently arrange for repairs at your home, credit could be the right option for you.

Take the time to consider which type of credit is right for your financial challenge. Take a personal loan for example. If you need to make a once-off purchase or cover an immediate expense, a personal loan with a 10% interest rate could be a much better option than the credit card with a rate of 20%. Even though credit cards can be handy to reach for in an emergency, the interest becomes ‘not so good’ when you compare it to other alternatives such as a personal loan.

In addition, personal loans often have a fixed term which is designed to help you pay off the loan, not stay in the cycle of never-ending repayments which credit cards have a profound tendency to do.

Payday loans

Payday loans, as the name suggests, are loans that are designed to tide you over between pay-checks . A dangerous trap to fall into, payday loans are often accompanied by rates that soar into 40% territory and only give you a few weeks to repay the loan. To avoid having to obtain a payday loan, we suggest putting some money away each week in an emergency fund. That way if you need to tide yourself over you can turn towards your savings as opposed to being stung with the ‘not so good interest’ that comes with a payday loan.

Missed utility payments

What might be a little-known fact that could save you a lot of ‘not so good interest’? Did you know that if you miss a utility bill, you might be charged interest for the late payment? Missing utility payments might see you being hit with otherwise unnecessary (often exorbitant) fees and charges.

Naturally, paying the bills on time is our obligation. Life can also throw curve balls, or distract us from our personal accounting.  One of the most common times that a bill can be missed is when we move house and forget to redirect the mail to your new address.

Hot tip: a simple step you can take is to make sure you redirect your mail when you move house to make sure you avoid as much of the ‘not so good interest’ as possible!

So, what next?

Here are a few steps to help you reduce the amount of interest you pay.

Grow your savings account

The concept is simple: having a healthy savings account on hand will help avoid you turning towards ‘not so good interest’ when you want to fund a small to mid-size purchase. If you can't afford it, don't buy it.

Discover our other interest blogs

We've written three more jam-packed interest blogs if you want to learn more!

Disclaimer: Any information provided in this blog is of a general and informative nature only. While all reasonable care has been taken by Pioneer Credit Connect in compiling this information, Pioneer Credit Connect makes no representations or warranties, whether express or implied, as to the accuracy or suitability of the information contained in this blog.