Managing Debt - What You Need To Know
20th April 2018
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Debt comes in many forms – credit cards, hire purchase, car loans, personal loans, mortgages, student loans. There's no shortage of people out there wanting to lend us money! Borrowing money can seem like a quick fix, but carrying debt can end up being a serious drag on our finances.
What we all need to know before borrowing
Just because we can afford the repayments doesn't mean a loan is the best option. Getting into debt is quick and easy. Getting out is much harder and may take years. All too often the lure of easy credit becomes a problem that drags us down further.
Tip: We need to be wary of taking advice from the institution or person lending us money. They want us to borrow because they make money from the interest we pay.
What’s the true cost?
Deciding whether we can afford to borrow money to buy something involves more than just working out if the loan repayments are manageable.
For example, we may be able to afford to borrow money to buy a car, but what about the costs to register, run and maintain it? Plug all these costs into the budget before deciding if it's worth borrowing for.
There may be other ways to get what we want without borrowing money. For example, we could save or put things on lay-by and pay them off in instalments.
Borrowing to buy an asset
There are two kinds of assets – value builders and value losers.
Value builders are assets that are likely to hold their value, grow in value or bring in income after we've paid for them. So they can be OK to go into debt for. A house is the classic value builder (although houses can lose value, too).
As a rule, if we keep a house for the long term (more than ten years) the value will increase or stay about the same. And, if we needed to, we could sell the house and pay back our debt.
Education can also be a value builder. It can improve our job prospects and our income earning potential.
Value losers are assets that lose value after we've paid for them, like a common car. Every year the car is worth less. Borrowing to buy a car can be a risky move, especially if it loses value faster than we can pay off the debt.
Saving to pay expenses
Expenses are things that leave us with nothing after we've paid for them – like living costs, nights out, and holidays. Paying for expenses from income or short-term savings is ideal.
It can be painless to pay for a meal in a restaurant on a credit card. But if we take a few months to pay off the credit card, the interest charged makes that meal more expensive every day the debt isn't paid off.
Knowing all the options
When borrowing money we need to make sure it costs us as little as possible – why pay more than necessary? Even a small change in interest rates can make a big difference to the total we pay over time.
It pays to compare all the places that lend money. For example, a store will have different costs than a car yard.
It helps to have a think about:
- How much do I really need to borrow?
- How much interest and other charges will I pay?
- How much will my repayments be?
- How long will I be paying back the debt?
- How often will I make repayments?
- How sure am I that I want to take on this debt?
The trick is to keep the full cost in mind (which the lender must disclose by law).
Know the full cost before borrowing
Work out how much it will cost with interest included - our loan calculator can help.
Get out of debt fast - How to reduce debt
The longer we take to pay off
The quickest way out
Juggling several debts? The quickest way to get out of debt fast is to pay off the debt with the highest interest rate first, such as credit cards or hire purchase. Use our budgeting tool to make a money plan. (LifeLot members have access to our budget worksheet, which can be kept in your LifeLot account also).
Make a plan to get out of debt
Here’s how it works.
- Make a list of all your debts and the interest rate on each one. (Look up the interest rates in the loan agreements or credit card bill.) You may like to use the Personal Plan Template to help you get started.
- Identify which debt charges the highest interest.
- Make bigger repayments to pay off this debt faster. When it’s paid off, start paying more off the debt with the next highest interest rate.
The Sorted loan calculator can help with crunching the numbers.
Sometimes a bank or other lender can combine several different high-interest loans into one lower-interest loan for us. (A single payment can be a lot easier to manage than multiple ones, and we could save a lot of money by paying less interest.) This is called debt consolidation. We just need to be aware that repaying a new loan over a longer period could cost more in interest overall. The trick is to keep paying it down as fast as possible – and avoid racking up any new debts along the way.
If it gets hard to keep up with debt, talk to the person or organisation that lent the money as soon as possible. They may be able to work out a new repayment plan. There’s also free advice available through financial capability (budgeting) services - visit the Family Services Directory.
LifeLot members - be sure to keep your Financial section (must be logged in to view) of your account up to date. Keep an accurate record of all debt repayments you make, the frequency, amount, and the final payment date. Scan and upload any contracts and agreements - this is important so that if anything were to happen to you, your delegate can quickly and easily take care of your finances with minimal stress involved.
sources: https://sorted.org.nz/guides/before-borrowing | https://sorted.org.nz/guides/get-out-of-debt-fast
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