Better manage your debt this New Year

January 11, 2016

New data shows a majority of Australians are ‘worried' about their financial situation.

According to the findings of Mortgage Choice's inaugural Financial Confidence Survey, 52.4% of Australians consider themselves to be either ‘very worried' or ‘concerned' about their finances.

Mortgage Choice chief executive officer John Flavell said the results weren't altogether surprising as it is common for people to worry about the state of their finances during the festive season.

“People are always more stressed about money during the holiday season as they know it is an expensive time of year with presents to buy, lunches to host and various social events to attend,” he said.

“People don't want to be told to reign in their spending during the festive season and, the reality is, they shouldn't have to.

“Instead, Australians should use the New Year as a perfect opportunity to re-evaluate their financial situation and make paying off excess debt and debt management a priority.”

Mr Flavell said there are a couple of things Australians can do to better manage their debt and pay off any debt they have accrued quickly and painlessly.

“In the first instance, Australians should take the time to review their financial situation. By knowing what debt they have and the interest rates they are being charged, they can put together a plan of attack,” he said.

“One of the most common and effective ways to manage and pay down an excessive amount of debt is to look at consolidating all of the debts into one area – like the mortgage.

“Borrowers can speak to a broker about consolidating all of their debts – including personal loans, credit cards, car loans – into their home loan. This may be able to deliver borrowers with excellent savings, as they may ultimately pay less in interest.”

For example, say a borrower owes $20,000 on their credit card with an interest rate of 25%. If they make $500 repayments each month, by the time they have paid off their credit card, they will have paid more than $23,000 in interest.

Now, if the borrower consolidated that $20,000 debt into their 30-year, 4.2%p.a home loan, and continued to make the $500 monthly repayments, they will have paid off the $20,000 debt in half the time and paid just over $1,500 in interest – saving more than $20,000 in interest.

But while Mr Flavell said debt consolidation can deliver worthwhile savings, he said it is important for borrowers to speak with their broker about whether this is the right decision for their needs.

“A key downside of consolidation is that a borrower could turn a short term debt like a personal loan into a longer term debt. That means paying interest for a far longer period, and over time they could end up paying more in total interest charges. For this reason, consolidation works best if borrowers are prepared to knuckle down and make extra repayments on the new, enlarged home loan.”

Another simple but effective debt management technique is debt rollover.

“If a person owes a lot of money on one particular credit card, they may be able to speak to their lender about obtaining another credit card with a 0% interest rate for the first 12 months and then roll their other debt onto the new credit card. That way, any minimum monthly mortgage repayments will go towards paying off the principal debt, not debt and interest,” he said.

For this technique to work effectively though, Mr Flavell said the borrower needs to be committed to paying off their credit card in full by the end of the 0% interest period.

“If a borrower keeps putting additional expenses onto the card without paying it off in full, they can get themselves into a very bad debt cycle,” he said.

Finally, Mr Flavell said one of the best ways to manage debt in 2016 is to match assets with liabilities.

“In finance, one of the cardinal rules is to match your assets with your liabilities. In other words, it is important to avoid using short term debt to finance a long-term asset and vice versa,” he said.

“Borrowers should avoid using a credit card to fund their home purchase as they won't be able to use the value of their home to pay off the credit card. Similarly, it is a good idea to avoid taking out long term debt on short term assets – such as a 5 year personal loan on a used car. If a borrower takes out a long term debt on a short term asset, their asset will become redundant before they have finished paying off the loan.”