How to manage your debt

6 min read

Used wisely, debt can help us achieve many valuable personal goals. But it’s easy to lose track of our debts, and that can be the start of a serious spiral into financial trouble.

Know your debt levels

Debt can be used to build wealth but it also makes overspending easy. That is why it pays to stay on top of your debts. Assessing exactly how much you owe in total debt makes good financial sense. It’s as easy as adding up all the amounts you owe including your home loan, investment loans, personal and/or car loan plus credit card debt.

It’s not just the value of your debt that matters. Your ‘new worth’ is important too. This is the difference between the total value of your debts and the total value of all your assets. The important thing is that the value of your assets exceeds the total value of your debts.

Good debt vs bad debt

Not all debt is bad. Some debts, like a home loan or mortgage, are used to fund a property that could rise in value.

The danger zone lies with bad debt. This typically includes credit card debt which has been used to purchase items of no lasting value and which, in many cases, comes with a very high interest rate.

If you’re aiming to pay down debt, it can pay to whittle away the bad debts first.

Your household budget is a useful tool to manage debt

The whole point of drawing up a household budget is to have control of your income. By showing money coming in versus what you are spending money on, a budget makes it easier to see where you are overspending. If you are continually spending more than you earn, chances are, you’re also building debt. But make sure your budget is realistic. The reason many budgets fail is that they are almost impossible to stick to.

Personal loan vs credit card - make the right decision

When it comes to making big ticket purchases, a credit card can seem like a very convenient option. However credit cards can come with some serious strings attached. To begin with, you could pay a far higher rate than a personal loan. And with no end date for the debt to be cleared, the card issuer may only ask for monthly repayments worth 1-2% of the total balance. This could see you paying off the debt for many years to come – and all the while the interest meter is ticking over.

A personal loan on the other hand, has a set term. So you know when the debt should be cleared. The fixed repayments are also easier to budget for. The fact that it takes time to apply for a personal loan would probably make you reconsider whether you really need the purchase or not.

Prioritising and consolidating debt

It can make sense aiming to pay off ‘bad’ debt first. This way you will minimise interest charges on purchases that won’t increase in value.

Or try prioritising debt by the interest rate you’re paying. Aiming to pay off high interest debts first could see you save on overall interest costs.

How to pay off debt faster

One proven strategy to paying off debt faster is to make additional repayments (when dealing with non-fixed interest rate loans). It’s an effective strategy because no matter how small the extra payments are, this money will come straight off the balance of the debt, thereby reducing interest charges in the following month. That means more of next month’s payment goes towards repaying the principal. It’s an easy way to turn the debt tide in your favour.

Refinancing – is it right for you?

Refinancing simply means paying out an old debt with a new, potentially cheaper loan. It’s worth reviewing your debts at least annually to see if you could make savings by securing a lower rate product elsewhere.

If you need more flexibility, you may be able to refinance to a loan offering more features. Even if you cannot secure a lower rate, you may be able to refinance to a loan offering more flexible features that can make your loan easier to manage. There may be costs for refinancing, so it is important to find out more information before proceeding.

Any savings that lower your regular repayments can be used to make extra payments to help pay off the debt sooner.

Managing - and reducing - credit card debt

Credit cards make it very easy to spend – and overspend. So it always pays to regard the balance of your bank account as your spending limit, not the limit on your credit card.

Keeping card debt under control calls for a bit of self-discipline. If you see a purchase you can’t afford to pay for in cash, consider whether you really need it. Ask yourself how long it will take to pay off and remember, once card interest charges apply, a bargain may not be such good value at all.

Aim to stick with a low rate/low fee card, especially if you have an ongoing card balance. And always aim to pay more than the cardholder’s monthly minimum - otherwise it could take years to pay off even a small card balance. In the meantime you’ll be charged interest on the balance outstanding.

First and foremost, aim to pay with cash where possible.

Tips to help reduce debt

  • Aim to stick to your household budget – this will show whether you’re overspending on certain purchases.

  • Reach for a debit card rather than a credit card – you won’t pay interest charges using your own money.

  • Review your debt products regularly – paying a higher rate than necessary only makes it harder to clear the balance.

  • Focus on high interest ‘bad debts’ first – you’re more likely to save on interest charges this way. 

  • Pay more than the monthly minimum wherever possible – it’s the best way to get ahead with debt.

Where to get help if you're struggling with debt

Your financial adviser can show you how to live within a budget so that overwhelming debt doesn’t become a problem.

However if you are struggling to get ahead with mounting debt, there are a number of free or low cost financial counselling services that can help you map a path to freedom from debt.

Be very wary of services that claim instant relief from debt. Many of these could charge high fees or encourage you to take steps you may later regret like declaring bankruptcy or entering into a very restrictive debt agreement – both of which can show up on your credit record.

Need help managing personal debt? Contact us or speak to your financial adviser

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This information is current as at 15/08/2016.

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