4 Tips on Managing Your Bad Debt
Australians are world leaders in personal debt. Currently, the ratio of household debt to income is 212%; meaning that a household with an income of $80,000 will spend around $169,900 each year. Debt is an unavoidable part of Australian life, and this isn’t necessarily a bad thing. It is your responsibility to navigate through your personal debt. How can you start managing your bad debt?
For the individual, personal debt is almost certain. Whether you need to get the capital to open businesses or purchase your first home, chances are you will attract some debt over your lifetime. The challenge is taking on debt that makes it worth your while. We are passionate about educating our members on how to spot good debt from bad debt. We have watched our members climb out of bad debt situations and leap into good ones, watching their financial lives improve dramatically.
Good Personal Debt:
Debt on investments or purchases that are either necessary considerations or are delivering a financial return is good debt. The interest rate has to be low enough to make the debt cost-efficient.
Bad Personal Debt:
Debt that should have been avoided. This type of debt comes from expenses and purchases that are not assisting you to get ahead financially. Common types of bad debt are loans with unusually-high interest rates such as personal loans or credit cards used on lifestyle expenses.
Let’s review some different loan types and how they are classified.
A home loan that is reviewed regularly to and at a competitive interest rate is usually classified as good personal debt. We have discussed home loans at length in our “Purchase Property; Pursue the Australian Dream” blog. Yet when debt is the primary consideration, there are three major factors you should take into deep consideration:
Variable Rate vs Fixed Rate
As discussed in the aforementioned blog, you may opt for a loan with either a variable or fixed interest rates. Although fixed-rate loans offer the security of a fixed interest rate and repayment, variable rate loans typically attract additional benefits such as redraw facilities or offset accounts. This allows people to “pay off” their loans sooner by reducing the overall interest paid.
Interest Only Loans
During a set “interest-only” period, you only pay the interest applied on a loan instead of paying back the borrowed amount. A major drawback to this type of loan is that it tends to be costlier with banks applying higher interest rates. You will continue to pay interest on a fixed amount rather than a shrinking amount, ultimately leaving you with more interest to pay off. However, the “interest-only period” requires smaller repayments, and can be a strategy explored by property investors to keep their tax deductions as high as possible.
Owner Occupied vs Investment
Your home loan will also be either an owner-occupied (personally lived in) or an investment (bought to rent out). The key difference between these two is the level of interest applied. Banks reduce the interest rate on owner-occupier loans as there is less risk associated with this type of lending.
In short, debt on your personal home that you are reasonably able to pay off within the stipulated terms is “good debt”. Likewise, for investors, if the debt you have is to help you grow your wealth through property assets, you also have “good debt”.
Credit Card Debt
The most notorious cause of bad debt in Australia are the flimsy plastic card we carry in our wallets. ASIC has estimated that 18.5% of Australians are struggling with credit card debt. It seems that we are nationally predisposed to tap into a pool of money we don’t have. Credit cards can easily lead to “bad debt”.
The best way to avoid credit card debt is to not use your credit card. You will not be able to raise any significant amount of debt if you keep incurring more debt by being spendthrift with your credit card. Review your statements to see how and where you could cut out some of your spendings or if that spending is getting you closer to your dream life. If possible, you should cancel your credit card until you have your cash flow under wraps.
Transfer (if applicable)
A balance transfer is to move your outstanding balance from one credit card to a new credit card with lower interest. Banks offer repayment plans to their customers to ease repayment methods. Sometimes an interest-free grace period will be offered on the new card. Always read the fine print, however. There may be hidden fees or unfavourable conditions that come along with the transfer deal.
Pay more and sooner
People who pay more into their credit card than the required monthly amounts will not only eradicate their debt sooner but also save thousands of dollars in the long run from reduced interest payments.
Financial freedom is within your reach. Simply start by reducing bad debt!
Motors and wheels are the modern man’s horse and stirrups. Public transport does not always offer the readiness, reliability or timeliness that a personal vehicle does that is needed for some lifestyles. If the distance between home and work is large or you’re already leasing a car, your case for financing a car with a personal loan is completely justifiable. This is so long as you secure the best possible car loan. But how?
Find the best deal
Shop around. Car loans come in many shapes and sizes, so there is value in taking your time to find one that is right for you. Get in contact with us and the team at Pursue Property. Also make use of online personal loan calculators, such as moneysmart’s personal loan calculator to determine your ability to make the loan repayments.
To extract further value from the loan, a broker may want to tie-in several add-ons, two common ones being:
Loan Protection Insurance
Here, your insurance provider will cover the costs of your repayments in the event of extended illness, injury or involuntary unemployment. Other types pay the loan off in the event of death. More often than not, LPI does not provide good value for money. Life or income protection insurance policies may offer the same for less.
This will cover the cost of unexpected repairs, parts and labour for a period of time after buying the car. For new cars, this is unnecessary as most manufacturers provide extended warranties themselves. Used cars, which are older and therefore more costly to repair, are unlikely to benefit from a broker’s extended warranty as its cover for repair costs is typically capped.
As an alternative to personally leasing a car or financing one with a personal loan, you choose a novated lease. If your employer agrees, they will redirect contributions from your pre-tax salary into paying the car lease and its running costs, granting you tax concessions in the process. Full ownership of the car may be assumed with a balloon payment by you or your employee.
Although you may reap a few fringe tax benefits, a novated lease can ultimately be more expensive than a car lease, being Australia’s least popular way of financing a car on this list.
Business Declaration & Chattel Mortgages
If you’re using the loan buying a car for majority business purposes, you must sign a business declaration. This makes you applicable for chattel mortgages (car loans for businesses) which allows you to make GST deductions on your BAS come the next end of financial year.
Fresh on the block, AfterPay is a buy-now-pay-later service which has enabled nearly one million Australians to make loans on small purchases with no interest, only incurring late fees. Our director Josh has discussed the ins-and-outs of AfterPay in a previous blog: To Afterpay or Not to Afterpay.
Similar to how a credit card lets you use money you don’t have, AfterPay plays on its consumers’ worst compulsions. While you may purchase an item sooner rather than later, you are more prone to impulse buying. A survey by Mozo has revealed that about 65% of people who have used AfterPay admit to making purchases that they wouldn’t otherwise have made.