What is Debt Management?
Borrowing money can take many forms, from store credit at the local pharmacy to a mortgage to buy your home. Actively managing your debt is just as important or more, than any savings strategy you have in place. The impact of mismanagement can be significant on your bank balance and your ability to use debt responsibly to invest for the future.
Interest rates and terms of debt vary greatly. It’s not unusual for people to pay in excess of 20% interest on short term debt such as credit or store cards. Long term debt normally has a lower rate, but it takes much longer to repay it.
Many people are on the merry-go-round of repaying the interest on high-rate debt and never paying down the capital, to pay the loan balance. Consolidating these debts into a lower rate loan with scheduled principal and interest repayments can help break this cycle.
Getting advice on how to structure and consolidate your debt will help you consider the interest cost implications and manage the repayment in a way that supports your lifestyle and financial goals.
Small changes such as moving from monthly to fortnightly repayments can shave years off your mortgage. Paying a little more each week can do the same. Your financial planner can help you set a detailed budget so you know what money you can afford to allocate to your debt.
It might sound silly, but some types of debt are better than others and some debt is even considered "good" debt. Working our way from bad to good can look something like this:
- High interest loans with no fixed repayments – like a perpetual loan, it keeps on going.
- Long term loans – it is a trade-off for lower interest rates but it’s not a good idea to pay off a car over 30 years if the car only lasts 10.
- Non-deductible debt is when you can’t claim a tax deduction for the interest, like your home.
- Low interest and interest-free loans (if you pay it within the interest free period) can reduce the impact on your cash flow.
- Deductible debt is the "good" debt! Borrowing to invest, be it property or other investments, allows the interest to be tax deductible which may provide a reduction in your income tax payments. This is dependent on many factors including affordability – your adviser can help guide the way and determine if borrowing to invest is right for you. Refer also to the Gearing Knowledge Hub.
What should I be thinking about?
The T’s & C’s
The terms and conditions of loans will vary across the different types as well as product providers. Make sure you understand all the fine print of your loan agreements. Some of the more common features that relate to mortgage-style debt include:
- Fees: Upfront, monthly, transaction costs, break costs.
- Split interest rates: Fixed interest rates provide certainty whereas variable rates give you flexibility and link with market conditions.
- Flexible repayments: Weekly, fortnightly, monthly repayment options.
- Extra repayments: Can you pay more than the set repayment, or will you be penalised?
- Redraw facility: If you make extra repayments can you take them out again if you need them in the future?
- Offset account: Do you have the opportunity to put cash into an account that completely offsets the interest on your mortgage? In most instances, you can access this money any time and even get your mortgage repayments drawn from this pool of money.
- Repayment holiday: So you’ve made extra repayments and now you need to stop payments for a short period of time (normally 3-12 months). This can be an option.
- Loan portability: Moving to a new house? No problem. Your loan can go with you…t’s and c’s apply.
- Consolidating your debt into a longer-term loan with a lower interest rate means that it will take longer to repay.
- Significant changes to your cashflow such as your wage income, may impact your ability to repay your loan. You should seek advice if your experience significant cash flow changes.
- Changes to variable interest rates may impact advice relating to debt management.
- Loans require approval. Any recommendations to consolidate or change your debt provisions are subject to approval by your lender.
- Paying out your loan means you will no longer have access to this line of credit.
- There are additional fees for loan features such as offset accounts and redraw facilities. Make sure you understand all the costs for your loan agreement.
- Some loan contracts do not let you access additional repayments once they are made.