There may be times when you add up all of your debt or look at your credit card statement and worry about how to manage your debt position.
After such a long period of being in a low interest rate environment, the recent interest rate increases announced by the Reserve Bank of Australia may have you starting to worry. The Reserve Bank Governor’s interview during last week indicated there are more rate rises on the way before it stabilises. It might feel like you’re being sucked into a spiralling vortex, but there are things you can do.
To help manage your debt position, here are some quick tips.
Fix interest rates or stay variable?
The horse has bolted, the banks have already raised their interest rates in line with their own view on where the market will be. The benefit of fixing interest rates is that your repayments will not vary over the period of the fixed interest agreement. The disadvantage is that you are bringing forward an interest rate increase on yourself which may or may not occur at some future date. Variable interest rate loans will give you the greatest flexibility if your circumstances change, or are likely to change, in the future.
This doesn’t make the debt go away, but it can make your ongoing repayments more affordable, particularly if you are consolidating credit card and personal loans into your home loan, for example. Use the savings to pay down the debt faster if you are not sleeping at night or the level of debt is worrying you, this may ease the burden.
Use a Loan Offset Account
Set up your income sources to be paid into one consolidated cash account such as a loan offset account (‘LSO’) if available. Organise for all loan repayments to be deducted from the account automatically. This takes the worry out of paying things on time. Check with your loan provider, most lenders offer up to 100% interest offset for variable rate home loans. The balance in the LSO is offset against the principle of your mortgage and your interest payable is calculated on the difference. In effect it has the same impact as a voluntary reduction, however you retain full control of and access to the money. It provides tax free savings and helps you pay off your home loan faster. If your lender doesn’t offer an LSO check to see if you can make additional loan repayments which can be redrawn if needed.
Draw up a budget
Most people go to the trouble of doing a budget when they apply for a loan, but rarely do they continually monitor and review spending habits. Take a critical look at your budget, are there areas that are non-essential which you could be applying to servicing debt? Your mortgage broker, financial planner or lender can help you with this. There are lots of different apps out there that can help you with the ongoing monitoring. The cheapest and easiest is regularly reviewing your bank balance against your budget. If there are variances, dig deeper. If you need help, don’t be afraid to ask your trusted advisers for assistance.
Be smart with lump sums
You may be tempted when receiving a lump-sum payment like a tax return, inheritance or windfall gain to take that much-deserved holiday or to buy a new wardrobe or the latest sports car. Proceed with caution! Using the money, or a substantial portion, as a voluntary reduction to manage your debt gives a longer term benefit.
Get smart with credit
If used wisely, a credit card with an interest-free period and a drawdown facility (line of credit) on your mortgage can get you ahead at a low interest cost. Pay all of your salary onto your mortgage and use your credit card to pay all your bills and outgoings. Then drawdown from your line of credit each month to pay the credit card bill just before the interest-free period ends. Don’t spend more than you put into your mortgage each fortnight, and in fact, try to spend less.
Be wary of “interest-free” offers
These are broadly offered on electrical goods and furniture and can be a trap because the interest rate you may be required to pay on your outstanding balance at the end of the interest-free period is generally very high. Penalties may also apply if you are late with any payments. Before buying using such an offer, make sure you have adequate cash flows to enable you to make regular repayments with a view to paying off the loan before the end of the interest-free period.
Be careful of short-term lending facilities
Money exchange services are an example, and they can be very costly. Credit providers in Australia known as “pay day lenders” operate national distribution networks and specialise in short-term, high-cost loans to consumers experiencing a cash crisis. Such facilities should only be used as a last resort – even then I would suggest using extreme caution.
Keep some emergency money aside
While you may be juggling your finances to meet all of your commitments, it’s still important to build a small cash reserve for unforeseen circumstances. This will protect you from being forced to accept costly, short-term lending arrangements. Work with your financial planner to help determine what is appropriate for you. A good starting point or rule of thumb is 3 net pays or, for a small business, 3 month’s of personal expenses. If you are a farmer or have variable income, twelve months is best practice to work towards.
Pay your debts automatically
Talk to your employer to see whether you can have your salary paid into multiple accounts, including your debt accounts. The obvious benefit is that your income flows will be better managed and the money disappears before you get it, thus reducing the temptation to spend instead of repaying debt. Alternatively, have set amounts deducted from a nominated account to automatically pay outstanding debts. The trick here is to make sure you have enough money in the account when the deduction falls due, otherwise your bank may hit you with a nasty fee for dishonouring the arrangement.
If I’m suffering mortgage stress now, what should I do?
It’s better to act as soon you start to feel under pressure to give you the most options to manage your debt position. First steps include:
- Talking to your mortgage broker or financial planner or lender about your situation
- Temporarily switching to interest only on your loan
- Cutting out unnecessary expenditure
- Reviewing and implementing the other 10 action items above as appropriate for your circumstances.
This is general advice only. The key message here is don’t be afraid to reach out and speak to your trusted advisor for personal advice addressing your concerns to manage your debt. At Financial Services SA, Dibbo is able to assist you in a number of ways, either wearing his business/farm consulting hat, mortgage broking hat through Riverland Lending Service or financial planning hat through Fortnum Private Wealth.