Debt management
What are the different types of debt?
Debt can be classified into three types, depending on the expected duration of your repayments.- Short-term debt is ideal for small borrowings that can be repaid quickly, eg credit cards.
- Medium-term debt usually requires security or collateral, eg personal or consumer loans for holidays or new cars.
- Long-term debt allows you to fix or vary interest repayments, eg a mortgage, with your house as security.
Debt can also be active or passive, depending on whether it can be used to generate income.
- Active debt is tax–deductible, with interest repayments and other expenses also deductible. This type of debt costs money, but can also make money, eg loans for investment purposes and margin loans.
- Passive debt is non-deductible, where the borrower bears the entire cost, including interest, eg credit cards.
Debt can also be regarded as good or bad, depending on the value of the assets it is used to purchase.
- Good debt is used to buy assets that are likely to pay income or increase over time, like a house or investments.
- Bad debt is used to buy things that depreciate value, like cars and televisions.
Is saving better than debt?
Saving is simply putting excess income aside until you’ve accumulated enough to purchase what you want. In contrast, debt is where you enjoy your purchase first, then ‘save up’ the money to pay for it. Saving for a specific goal may take longer than you’re prepared to wait, so taking on debt may seem like a good option. However, once you’ve factored in the additional costs associated with debt (such as interest, application fees and other charges) the original purchase may cost you more than you first thought.How does debt mount up so easily?
Debt is simply something owed by one person (the debtor) to another. When taking out a debt, you accept an obligation to repay the lender both the original sum you borrowed (called the ‘principle’) and also any interest or other charges set out in the loan agreement.When making a purchase using debt, it’s often more convenient to simply accept the first option offered to you. You can easily end up repaying a series of debts, all of which have different terms, conditions, fees and interest charges and repayment dates.
What began as the easiest option at the time can quickly become a confusing maze of multiple monthly repayments, due on different days, to different institutions.
It can also become very expensive, as each debt will usually have associated start-up costs and ongoing account-keeping or maintenance fees and charges. Interest is not the only cost you pay on debt products and government fees in the form of stamp duty are often levied as well on each new borrowing.
What happens if I lose control of my debts?
Using debt to cover the difference between what you earn and what you spend is a dangerous practice, which may lead to personal and financial distress. Apart from the stress associated with excessive debt, losing control of your debt may lead to denial of further credit, insolvency or even bankruptcy.If you find you’re having trouble managing your debt, it’s important to keep in touch with your credit providers to make sure they’re aware of your circumstances. You may be able to negotiate repayment of the balance owing over an extended period of time.
What are the eight golden debt rules?
- Stability of income – consider the stability of your income and any financial commitments before you go into debt.
- Maintain liquidity – ensure you have enough cash flow (or assets which can be easily converted to cash) to meet financial commitments.
- Maintain a manageable level of debt – try to keep debt payments to no more than 30 per cent of your gross income.
- Repay your credit cards as a priority – it may be tempting to pay only the minimum amount each month, but you’ll be surprised how quickly the interest can accumulate.
- Limit the use of your credit card – only use credit cards when you don’t have immediate access to cash.
- Consider personal risk insurance – it may be worthwhile taking out personal risk insurance (such as income protection or life and disability insurance). Remember, an end to your income doesn’t mean an end to your debts.
- Save for assets which depreciate over time – save for cars, holidays and depreciating assets rather than using debt to purchase them.
- Seek competitive credit rates – shop around for the cheapest form of credit. Don’t fall victim to the convenience of taking on a credit agreement at the point of sale if you can obtain a more competitive interest rate elsewhere.
How can I use debt to my advantage?
When you use a credit card, take out a car loan or take on a mortgage, you’re using debt. Although you may think of it as ‘credit’, it’s actually debt because you become ‘indebted’ to the money lender.However, for most of us debt is a necessity. If it weren’t for mortgages many of us would never be able to buy our own home. If used properly, debt can be a valuable financial management tool, but it is recommended that you seek expert advice before borrowing for investment purposes.
Should I consolidate my debts?
Debt consolidation is the process of replacing several separate loans (or debts), with one new loan (or debt). For example, you may have an existing home loan, a car loan and also some credit card debt. A new loan (secured against your home) is taken out which effectively pays out these three debts and then continues to operate as a normal home loan.But is debt consolidation the right answer for you? The ability to combine a number of debts into one ‘neat package’ is attractive. But consolidating your debt has advantages and disadvantages, depending on your individual circumstances:
Debt consolidation – advantages
- The annual interest paid on the new loan is usually less than the total annual interest paid on multiple debts.
- Annual repayments on the new loan will often be considerably less.
- Ongoing transaction costs associated with one consolidated loan may be significantly less.
- A single consolidated loan is easier to manage, with just one monthly statement and one monthly payment.
Debt consolidation – disadvantages
- A loan which might otherwise be repaid over a shorter term will now be all repaid over the longer term of the new loan.
- The longer term of the new loan means total repayments could be considerably greater unless you make additional early repayments.
- There may be costs associated taking out the new loan and early repayment.
Why do I need to review my debt regularly?
To manage your debt effectively you need to review what you owe regularly, to ensure that you are not paying any more than you should and whether the long-term lending product is still the right choice for you.* The Australian Bureau of Statistics
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As at 30th March 2011, AXA Asia Pacific Holdings Limited and all of its Australian and New Zealand subsidiaries ceased to be members of the Global AXA Group and became members of the AMP Group.
