Debt in Australian households has ballooned in recent years. Bruce Brammall, author of Debt Man Walking, shows you how to get financially fit.
Debt in Australian households has ballooned in recent years. And falling interest rates are only masking the problem in many households.
Debt needs to be repaid. If your debt is getting control of you in the current economic climate, there’s a fire burning.
Debt ain’t debt
Not all debt is evil. Some debt is better than other debt. As I outline in Debt Man Walking, there are three types: dumb, okay and great debt.
How do you distinguish between the different types of debt? You need to ask:
Is the item purchased likely to increase in value?
Can you claim the interest as a tax deduction?
Dumb debt: If the debt answers no to both questions, it’s dumb debt. Examples are credit card and furniture debt and loans taken out for holidays, weddings or honeymoons.
Okay debt: This answers yes to one, but not both. Your home will increase in value, but is not a tax deduction. A work car will be a tax deduction, but will fall in value.
Great debt: Yes. To both! This sort of debt is what is used to buy investment property or share portfolios. This is the sort of debt that is good for your wealth.
Got that. What do I do now?
Categorise and prioritise all your debts into dumb, okay or great debt. Dumb debt is first in the firing line.
“Dumb debt” is used to buy items you should have saved for. It probably would have only taken a few months of solid saving. But you didn’t save, so you’re now paying around 18% interest on that purchase.
There is little point having money in your offset or redraw account on your home loan, saving your 6% in interest, if you’re paying three times that on your credit card bill.
A favourite 80s saying was “no pain, no gain”. And there’s an equivalent for your finances. It’s the principle of “delayed gratification”.
Delayed gratification is the first universal law of money, particularly when it comes to paying down dumb debt. It should be obvious: if you spend $1000 now, it can’t be used to pay off your credit card.
It’s a bit hard, if not impossible, to pay down debt when the equation looks like this. Income: $1000. Expenses: $1200.
But this is literally how many of us live. By definition, in order to have been able to pay for that extra $200 of goods, you borrowed it from somewhere.
If cutting your spending doesn’t come easily, set a budget. A good budget will take into account how much you earn, what your inescapable expenses are and will help you identify where you fritter money away. It’s the frittering that is causing the financial damage.
Identify it. Then, like the Daleks used to do, EX-TER-MI-NATE it. You might not be able to get rid of it all, but cutting your spending below your income is critical.
Cut your credit card limit
As you pay down your credit card, remove temptation. Call the bank and have your limit reduced. If they resist, ask them what paperwork you need to fill out to make it happen.
Consolidating many small debts that have high interest rates makes sense. If you can bundle together, say, at least $30,000 worth of credit card and personal loans, a bank might be able to roll this debt into a loan with a lower interest rate. Another way of consolidating debt is to roll it onto the home loan, which will usually have a lower interest rate than other forms of debt.
However, be warned: This is only a good move if you are able to stop yourself from running up the debt gain. If you know that you will only run up the credit card again, then this is not the right option for you.
In trouble? Get some help
Most lenders do not want to send their clients bankrupt. If you’re getting behind on the repayments, contact your lender or a financial counsellor immediately. Professionals might help you strike a deal with your lender that could stop things getting nasty.
Get on top of things
Today’s financial woes will never go away if you don’t have a plan to stop them being a problem at some future point. Like New Zealand model Rachel Hunter said, “it won’t hippen overnight, but it will hippen”.
Bruce Brammall is the author of Debt Man Walking – A 10-Step Investment and Gearing Guide for Generation X, columnist and financial adviser. Debt Man Walking is available from most good bookstores, or online through www.debtman.com.au