Debt is often referred to as one of the ‘3-Ds’ – alongside death and divorce – each of which can be devastating to people’s lives because of the financial stress they cause.
In fact, the latest AMP.NATSEM report has revealed a quarter of Australians (24 per cent) are experiencing financial stress from things like paying bills, raising emergency funds or having to ask friends or charity organisations for financial help.
The Buy Now Pay Later report found average Australian household debt now stands at $245,000 – four times what it was in 1988 when the average debt for households was $60,000.
Even though low interest rates have softened the blow on mortgage repayments, low-income families experience six times more financial stress than high-income families who can generally cope with the financial burden of a big mortgage because of their higher level of income and wealth.
No matter what your income level is, for most people debt is becoming a much bigger part of life, which is why it’s really important to recognise the difference between good debt and bad debt. Quite simply, good debt builds wealth, bad debt diminishes it.
If you borrow to invest, and the investment earns money, debts can be paid off from the earnings. In this way, the debt is actually working for you. That’s good debt.
On the other hand, if you borrow for a new car or overseas holiday, or used credit cards to splurge on designer clothes and shoes in the post-Christmas sales, you can be behind in two ways – you’re left with something that loses value, while having to pay high interest payments. This is bad debt.
While it’s not always possible to avoid bad debt, there are strategies to reduce it – and some small steps you can start taking right now to make a speedy recovery from a Christmas credit hangover.
1. Start a budget
Before debt spirals out of control, start taking control of your finances and get a grip on your everyday spending and cashflow. Keeping up with the Joneses can put unnecessary financial pressure on families so learn to differentiate between needs and wants. Use one of the many online budget trackers provided by financial institutions. Once you know what’s coming in and what’s going out you can see how much money is left over at the end of the week or month to save, invest or start paying down debt – and where you need to cut back on spending.
2. Prioritise your debt
You need to be clear about what you owe – how much, what kind of debt it is and at what interest rate. Consider paying off any non-tax deductible ‘bad debt’ first, such as credit cards, personal loans and home mortgages. Prioritise your bad debts and work out which ones are costing you the most in interest, penalties or fees, then start repaying them in order of priority.
3. Tackle credit cards first up
If you continue to buy today with tomorrow’s money, you could be heading towards the big dipper of debt which can take a long time to climb back up from. Credit cards are convenient if paid off in full each month, but if there is a large amount of debt sitting on a card, it could be costing you big time as interest rates on credit cards can be as high as 20 per cent or more. To pay off this debt as fast as possible you will need to make more than the minimum repayments each month. If you have several cards maxed-out, consider rolling all the debt onto one card.
4. Use spare cash to pay off debt
We all need to spend some disposable income on ourselves, but consider setting up an automatic spending plan – pay your debts down first, allow an amount for larger short-term expenses like holidays, then spend what’s left (avoiding credit cards), rather than spending first and trying to find the money to reduce debt later.
5. Start reducing your mortgage
What’s most likely your biggest debt – your home – will increase in value over time and is a really good asset to have. However, it generally doesn’t generate an income for you and the loan interest charges on your home loan are not tax deductible, so it’s important to reduce your home loan as quickly as possible. Start paying a portion of income directly onto your home loan and use a credit card for daily purchases to help make savings on interest payments. Of course, this will only work if you pay off your credit card debt each month.
6. Have a plan for financial shocks
As a contingency for life’s unexpected expenses, it is essential to either have an emergency fund or access to cash through a mortgage redraw facility or offset account. A good rule of thumb is to have at least three months’ salary in the kitty. This may seem a tall order, but it’s worth starting to build this up as a vital resource and to avoid the need to rely on credit cards in the event of an emergency.
7. Protect your future income
The AMP.NATSEM report shows the increase in average income over the years has enabled people to increase their debts and take bigger risks, which is why it’s more important than ever before to seek advice about protecting your future income. Without income protection, if your ability to earn an income is disrupted because of illness or injury, then this has a direct impact on your ability to maintain debt repayments.