The Debt Economy: How It Works And the Ways Out of Personal Debt

When a bank makes a loan, it can create the deposit it lends. Owing money is not a personal failing. It is one of the ways the system runs.

General financial education only. This article is not financial advice and does not consider your personal objectives, financial situation or needs. It explains how the common ways of paying down debt work and what each one trades off. It does not say which suits you, and it names no lender, card or product. Before deciding anything about a debt, consider talking to a free financial counsellor, or a licensed financial adviser for questions beyond the debt itself.

“The debt economy” is a phrase rather than a measure. It describes an economy that runs on borrowing: banks can create money when they lend, and households owe a great deal back. At June 2026 the Australian Bureau of Statistics counted $3,521.1 billion of household liabilities. The common ways out of a personal debt make a short list. Moneysmart, the government’s guidance site, describes paying the highest-cost debt first, paying the smallest balance first, and consolidating. If repayments on a personal or household loan are already out of reach, the lender must consider you for hardship assistance, and financial counselling is free.

How lending makes money

A loan looks like a transfer. One person had the money, now another has it. The Reserve Bank describes something different. In its 2018 Bulletin it says that when a bank extends a loan it makes a sum of money available to the borrower, and that the bank may credit the borrower’s deposit account. Deposits can be created that way. The Reserve Bank’s explainer says deposits held with a financial institution are a digital form of money and make up the greatest share of money in a modern economy.

The Reserve Bank’s wording is more careful. It says the process does not mean banks can make loans and create money without limits, and it does not say “most” of Australia’s money is created by lending. The Bank of England does say it, about the United Kingdom, in a 2014 paper: the majority of money in the modern economy is created by commercial banks making loans.

In a system where lending creates deposits, debt is part of how the money you earn comes to exist. That describes the system and passes no judgement on anyone who owes money inside it.

The ABS figure covers the whole household sector, an accounting category, and is not what any one household owes. Of the $3,521.1 billion, the ABS puts long-term loans at $3,312.4 billion and short-term loans at $60.6 billion. It says the rise in household borrowing over the June 2026 quarter was driven by continued strength in new loans for housing.

Why nobody explained it to you

Interest was a moral argument before it was a product. In medieval and early modern Europe, canon law forbade any return on a loan beyond the principal as usury, and the Catholic Church acknowledged the legality of interest only in 1828. Closer to home, hire purchase began in Melbourne in the 1860s with sellers of musical instruments, and it spread because banks would not make small personal loans.

Then there is who could borrow. Australian banks required a woman to produce a male guarantor for a loan into the 1970s, a general practice rather than a policy any one bank dated and published. Sex discrimination in the provision of services, which includes lending, was made unlawful in South Australia from 1976, in New South Wales from 1977 and in Victoria from 1978. It did not become unlawful across the whole of Australia until the Sex Discrimination Act 1984 (Cth) commenced, on 1 August 1984. The bank account note has the state-by-state detail.

A product that was not offered to a woman on equal terms had little reason to explain itself to her, and it did not. The newest form, buy now pay later, was brought under credit law only recently: from 10 June 2025, a buy now pay later provider must hold an Australian credit licence. If nobody ever walked you through how credit works, you were not behind.

Start with the list

Every method below begins with the same step, which Moneysmart sets out first: get a clear picture of what you owe. For each debt, write down the balance, the current interest rate, the fees you pay including any penalty for paying the loan off early, and the remaining term.

Moneysmart also separates debts from bills. Some payments, it says, need attention first because missing them can cause bigger problems: rent or mortgage, council rates and body corporate fees, electricity, gas, water and phone, and car repayments if you rely on the car for work or essential travel. If you cannot pay one of those on time, it advises contacting the provider and asking for an extension or an instalment plan.

Only after those does it turn to paying down the rest. A budget is where the amount available comes from, and how to start budgeting covers that part.

How the repayment methods work

Moneysmart describes two ways of working through a list of debts. Each pays the minimum on every debt and sends whatever extra there is to one debt at a time. They differ in which debt gets the extra.

Moneysmart’s own summary sits at the end of its list of methods: the important thing is to choose the method you can stick with. That is Moneysmart’s general guidance. This page cannot see your numbers and does not recommend either order.

Here is how the two orders differ on three invented debts. The balances and rates are illustrations, not typical figures and not a projection. To keep the example simple, none of the three charges fees, so the highest cost is the highest rate. With fees in the picture, the order can change.

The orders differ only for the first two. Debt C is last either way. With the same extra amount going in each month, each order puts a different goal first: the most interest saved, or the earliest debt cleared.

“Pay the minimum on all debts” is part of both methods because a missed minimum has its own cost. Moneysmart notes that paying a credit card on time avoids extra interest and late fees and helps keep your credit score healthy.

What consolidation changes

Debt consolidation means rolling several debts into one new loan, so you make one regular repayment to one lender. Moneysmart lists what can be consolidated: credit cards, personal loans, store cards, buy now pay later and car loans.

Moneysmart’s own illustration takes a $20,000 debt and changes only the rate and the term, then shows what each version costs in total.

A lower rate over a longer term reduces the weekly repayment, and in Moneysmart’s words could increase the total cost. The lowest rate in the table has the highest total.

Moneysmart gives four conditions under which consolidating may help: you pay less overall, the new term is not longer than your current debts, you can afford the repayments, and you stop using the old credit. If some of those are not true, it says consolidation can make things worse.

Two more cautions come from the same page. Turning unsecured debts, such as cards, into one secured debt puts the asset at risk, because if you cannot pay, the lender can sell the home or car you put up as security. And some companies promise to get you out of debt no matter how much you owe, which Moneysmart says may be unrealistic. It points to ASIC’s professional registers to check whether a company is licensed.

When the repayments are already out of reach

Everything above assumes the minimums are being paid. When they are not, the question changes.

Financial hardship, in Moneysmart’s definition, is when you are unable to make a credit or loan repayment. For a loan for personal or household use, such as a credit card, personal loan, car loan or home loan, your lender must consider you for financial hardship assistance when you ask. Options can include a payment plan or a change to the repayments, temporary or permanent. Moneysmart says there were more than 280,000 hardship notices across Australia in the 2024-25 financial year, and lists the top five reasons: overcommitment, reduced income, medical reasons, unemployment and separation.

Three details shape how a request works. A lender does not need your life story: typically it asks why you are seeking help, your income and major expenses, and what repayments you can afford. Moneysmart says a hardship arrangement will not affect your credit score, though your credit report shows that an arrangement is in place, and the listing is deleted after 12 months. And if the lender refuses, it must give reasons, and you can complain. The Australian Financial Complaints Authority hears complaints for free, and the first step is to contact the business.

Financial counselling is free, confidential and independent. The National Debt Helpline, on 1800 007 007, connects you to a financial counsellor, who can help with a hardship application. Opening hours are on ndh.org.au.

Beyond that sit the formal legal options, bankruptcy and debt agreements, on which the Australian Financial Security Authority publishes information. Moneysmart describes them as formal options with long-term effects: bankruptcy lasts three years, subject to extension in certain circumstances.

A bankruptcy stays on the credit report for five years, or for two years after it ends if that is later, and stays on the National Personal Insolvency Index permanently. Moneysmart’s advice is to explore the other options first, with a free financial counsellor.

The question this page does not answer

“Should I pay off debt or invest?” belongs to someone who can see your figures. What a page can do is list what the question is made of: the rate on the debt, any fee for paying it off early, how long the debt has to run, tax, and what you need to be able to reach. Weighing them against your circumstances is the work of a licensed financial adviser, and a free financial counsellor can help with the debt side of it.

Study loans sit outside all of this. They charge no interest, and how HECS debt works explains what happens instead.