Today’s blog is about a finance topic that no one likes to talk about and no one likes to have in their life but is everywhere in today’s society. I am talking about the D word ‘debt’ which is defined on the Investopedia website is “an amount of money borrowed by one party from another”.
Australians have one of the highest household debt levels in the world! Which is scary when you think about what that means for the average Australian household’s financial situation. Lots of debt equals lots of interest repayments to the bank, which means less money for you to live the life you want. We want to provide you with some strategies to help you get rid of your debt.
Before we move on let’s look at some debt stats of Australian households:
Household debt- $2.737 Trillion dollars!*1 This figure is made up of all the debts that Australian households owe. The website states that Australia’s household debts have increased from $173.5 billion to $2.2 trillion from December 1989 to December 2017 – an increase of 1,100%!
Credit Card debt – $27.2 Billion dollars*2 with the average debt per card holder in Australia being $3,231. This equates to interest payments of $646 per annum.
Ok so, we have given you some debt stats and as we mentioned they are pretty scary but let’s look at what makes up those household debt numbers:
- Home Loans
- Credit cards
- Personal loans
- Car loans
- Store cards & other consumer debts
There is an endless supply of debt options available in the financial market and you only have to look at the Big 4 banks profits each year (usually in the Billions), to see why they love handing out debt to us as consumers.
Debt is where the majority of banks’ profits come from each year. This profit comes from the interest they charge you on the loans outlined above that we all have with them. The way the system works is that the banks will only ever look to charge you the minimum repayment amount that they have to because this is very profitable for them! Let’s look at a couple of examples:
Home Loan Example:
A $750,000 home loan with an interest rate of 2.8% will end up costing you approx. $1,118,354 over the 30 year loan term you have with them if you only ever pay the minimum repayment amount they ask you to make – $3,107/month. This is $368,354 in interest to the bank over the life of your loan with them.
Credit Card Example:
A $5,000 credit card debt with an interest rate of 19% will end up costing you approx. $20,121 and take 38 years to pay back if you only ever pay the minimum repayment amount they ask you to make – $102/month. This is $15,121 in interest to the bank over the life of your loan with them.
Now don’t get me wrong, not all debt is bad. Borrowing money to purchase a home or an investment property is a good thing. But when debt is used to buy clothes, holidays or things that don’t grow in value over time/give you an income, it’s a different story!
We are a nation of consumers, buy now and worry later and this is shown in the debt stats we discussed earlier, $27 Billion in credit card debt!! At the end of the day what debt does is, it costs you. It costs you money every month through interest repayments and it costs you experiences that you could be doing, if you didn’t have to make those interest repayments each month. When interest rates get higher or your debt levels get bigger it can also cost you a lot of stress, happiness and in worst cases relationships.
A debt free life or one without credit card debt and other consumer debts, is one of freedom where your money is yours each month and not going to the banks to boost their profits. This is what we want for our clients and anyone reading this blog post.
So to help you work towards this debt free life and one not restricted by monthly debt repayments, we are going to discuss a 5 step action plan that you can implement today to destroy your debts!
Stop using your credit card to fund your living expenses. Chances are you are likely to spend more money on your credit card than if you were to use your own money each month.
A study by MIT students in 2000 found that people were willing to spend 113% when using a credit card for a purchase verses using their own money.
I know it seems like a great idea to buy everything on your credit card each month and get points for your purchases, with the plan to pay off your card each month. In reality though, I have found that this rarely happens and most people end up carrying a debt and having to pay interest on everyday expenses.
Work out exactly what you owe and what it costs you each month in debt repayments. We are all busy and live fast paced lives. After a while of being on the debt train we can lose track of exactly what we owe and how much this debt costs us because we get so used to just making our repayments each month.
Before you can move forward and get rid of your debt you have to have a clear understanding of where you are starting from. So, grab a pen and paper and draw four columns with the below headings and then fill in your debt info:
- Column one – type of debt e.g. mortgage, car loan, credit card etc.
- Column two – amount owing
- Column three – interest rate
- Column four – monthly repayment
Work out if you can lower the interest rate you have on any of your debts, to lower your monthly repayments. Things you can consider include mortgage refinance, debt consolidation (all debts into one loan), balance transfer for your credit card and calling your lender to negotiate a lower interest rate.
By lowering the interest rate you need to pay the bank, you will reduce your minimum monthly repayment and free up cash flow each month. We will be looking to use this extra cash in step four.
Now it’s time to destroy your debts one by one! The process outlined below is called “domino your debts” and is something I have borrowed from Scott Pape, the Barefoot Investor.
Now that you have an idea about how much you owe and what your minimum monthly repayments are on each of your debts, what I want you to do is continue to pay the minimum repayment on all of your debts each month. There is an exception to this: the smallest debt you have – the one with the smallest balance owing.
I want you to focus on paying as much as your budget will allow in extra repayments on your smallest debt each month, until this debt is paid off.
Now the math’s geeks out there will say “isn’t it better to pay off the debt with the higher interest rate, rather than the debt with the smallest balance owing?” Mathematically this may be the right move, but psychologically what I want you to get is a win.
When you knock off one debt it feels good. It will get the finance juices flowing and have you excited to move forward and get rid of your next debt. By focusing on your smallest debt first, we can ensure that you have that winning feeling in the shortest possible time.
Once your smallest debt is cleared, repeat the process and move onto your next smallest debt. This is where we start the domino process and you continue to destroy your debts with extra repayments.
By now, you will have some momentum and because you have cleared your first debt, you will be able to get rid of your next debt in no time at all. This is because you will be continuing to pay the minimum amount that you were previously paying on this debt each month (when focusing on your smallest debt). But you will now be able to increase this repayment by the minimum amount you were paying on your first debt plus the additional funds you pulled from your budget to pay that debt off.
The above process is how you can build some momentum and domino your debts! Along the way, once each debt is paid off, make sure you have a celebration for your victory. It’s important to reward yourself for positive behaviour, as it reinforces the good habits you are building. Just make sure you don’t go overboard and please don’t use your credit card for the celebration. J
As we have said throughout this blog, a debt free life is one of freedom. The sooner you are free of consumer debt – credit cards, personal loans/car loans, store cards etc. the better your life will be.
You will have more money available each month to put towards travel, experiences, savings and investments. To use this is freedom and is why being in control of your money is so important to us.
We hope this blog has been helpful and has given you some practical tips that will help you to destroy your debts and become debt free in the fastest possible time. If you are stuck on a debt treadmill and need some help we are only a phone call away.
Ryan Porter is a Wealth Coach at Catalyst Wealth Group. His mission is to help his clients achieve financial success and live their ideal life.
Disclaimer: Any advice or information in this publication is of a general nature only and has not taken into account your personal circumstances, needs or objectives. Because of that, before acting on the advice, you should consider its appropriateness to you, having regard to your objectives, financial situation or needs.
*2 (according to official RBA stats as at November 2019)