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Managing Debt

Written and accurate as at: Nov 24, 2020 Current Stats & Facts

Credit cards, mortgages, car loans, store credit, investment loans and business loans are all ways of borrowing money to achieve different goals. While they may achieve different goals, they are all fundamentally the same; you borrow a sum of money and repay it over time, with interest. 

Borrowing money can lead to positive or negative outcomes depending on how you actually go about it, and how this strategy is carried out over the life of the loan.

What am I borrowing for?

The terms good and bad debt is sometimes used to refer to certain situations when we borrow money.  A 'good debt' generally refers to debt which is used to invest in an investment asset, which might appreciate in value and provide income over time. Examples are borrowing to invest in property, shares, or a business. In many cases, this type of debt will attract favourable tax treatment with the interest paid often being considered a tax-deductible expense. Please note, there are exceptions to this and tax advice is highly recommended.

'Bad debt' refers to a situation where you borrow money to invest in something which doesn't hold its value - like a car or a TV. Bad debt also refers to credit card debt which has accumulated through paying for goods and other everyday expenses.

Should I borrow?

Whether you should borrow depends on what you are trying to achieve and on your ability to meet regular loan repayments as well as not compromising your standard of living. Based on the above description of good and bad debt, it's difficult to justify the benefits of racking up a credit card debt to buy consumer items just to satisfy the urge to go on a shopping spree. Another option may be prioritising your objectives based on your needs and wants or another could be saving the money if possible.

If you wish to purchase a property to live in or rent out, it can often make sense or a requirement to borrow. This type of asset often increases in value over the longer term (although this is not guaranteed), and it would take a long time to save enough money to pay for it in cash.

If you borrow to purchase an asset (such as property, shares) that produces an income, not only can the income you receive help to pay the interest repayments but there may also be tax advantages associated with the interest cost of the loan.


Managing risk

When increasing your debt levels, you also increase your living costs, and accordingly, it's important to put in place or review your Income Protection insurance, which replaces part of your employment income if you are unable to work due to illness or injury. It's also highly recommended to review other insurances such as Life insurance and Total and Permanent Disability insurance when increasing debt levels.

It may be also worth stress testing your finances to see how you would fare if there was an increase in interest rates.

How to reduce debt faster
There are some things you can do if you are struggling to reduce your debt. Firstly, by completing a budget you can work out where you can make savings and direct those funds into your loan. If you have assets you can sell then these too can be used to reduce debt. What can you sell online or sell at a garage sale? Do you have a bike that you never use, baby gear or car seats?

In the case of a mortgage, a useful strategy may be the use of a mortgage offset account to direct your savings into. This means rather than receiving say, 2% interest on your savings whilst being charged 4% interest on your mortgage, your savings will be offset against the balance of your mortgage. This effectively means you are achieving 4% on your cash savings!

One of the most overlooked money-saving tools is an appropriate loan repayment frequency. Most lenders will allow you to make your mortgage payments at intervals that suit your needs and preferences yet most of us will choose to make monthly mortgage repayments on our home loans. Switching to weekly or fortnightly repayments may make it simpler to manage repayments from a budgeting perspective. Additionally, the earlier you make a payment off your loan, the more it saves you in interest and therefore how long it will take to pay the loan out.

If you have multiple debts it may be beneficial to consolidate and refinance your debts. This means establishing a new loan by combining all of your existing debts into one. Do this at the lowest possible fees and the interest rate you can achieve with only the appropriate features for your needs. When dealing with a bank, don't be afraid to try to negotiate a rate lower than the advertised rate. You may not need to change banks; by simply calling and telling the bank you are considering moving, they may offer you a better deal anyway.

If you are not confident dealing with a bank directly or you want to shop around you're lending without doing all the work yourself, you could consider using a broker.

I can't afford to pay off my debt
If you are having trouble meeting your commitments, then it's important that you do something about it as you might not realize the effect it's going to have on your credit. Your credit card payments and level of debt have the most impact on your credit score. A poor credit score may make it difficult to obtain credit or borrow in the future and if you do secure credit, it will generally be at a much higher interest rate.

Accordingly, if you find yourself falling behind in loan payments, with seemingly no way to get up to date, it's important to take action.

One option is to look at refinancing the debt. You may wish to try to negotiate with your bank or lender. Contact them and explain your situation, and explain how much you are able to pay now and when you will be likely to make another payment. In many cases, they will be obliged to consider part payments and late payments. Make sure any agreements are provided in writing and make a note of discussions you have during phone calls.

Another option is seeking help from a financial counsellor. Financial counsellors are skilled professionals who will guide you through your options and help you plan your way out of debt. Financial counsellors do not charge fees for their services.  Such services include;

  1. Suggest ways to improve your financial situation
  2. Determine if you're eligible for government concessions or support
  3. Provide advice on how to negotiate with creditors, government agencies or other business providers
  4. Help you apply for a hardship variation
  5. Explain the risks of bankruptcy and debt agreements
  6. Talk through the alternatives
  7. Refer you to other services, such as a gambling helpline, family support or legal aid

Debt plays an important role in our financial lives and knowing how best to manage it can ensure a good relationship with creditors and a positive credit rating.  You can access your personal credit rating from various agencies.  A good place to start is the ASIC Moneysmart site. Understanding your credit file enables you to make more informed decisions regarding your finances. 

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