Provided by Mercer: 8/4/08
Targeting non-deductible debt is a sound and effective technique in the fight against financial stress.
Yet more signs emerged this week to indicate Australia’s economy is slowing. On Monday, The Age reported Melbourne’s auction clearance rates had fallen to 63 per cent, down from between 80 – 90 per cent last year. It looks like Australians are tightening their belts.
Indeed, the past 12 months have been particularly turbulent with interest rate increases and share market volatility hitting consumer confidence. In a relatively short space of time, people have started switching from a ‘borrow and spend’ mode to a ‘budget and save’ mode.
One component of an effective budget is managing debt. In this article we’ll explain the key techniques of debt management and how to bring debt under control.
In Mercer’s financial education classes, we encourage people to observe four steps: identify debt, ascertain deductibility, prioritise and manage repayments, and stay committed over a set time period. Let’s look at them in detail.
Identify debt
Before tackling any problem, you first need to define it. Generally, debt can be divided into two different types: current debt and future debt. Your current debt, for example, includes outstanding monies on a principal residence, investment loans, credit cards and personal loans. Your future debt includes things such as a holiday, investments, education expenses, car expenses or the purchase of property.
Once you’ve done this, you can break debt into some additional sub-groups. For example, jot down your debts according to their rate of interest. This lets you see the extent of your liabilities side-by-side.
Ascertain deductibility
The interest and expenses on your debt will be either deductible or non-deductible for taxation purposes.
You can claim a tax deduction for the interest and expenses on some forms of debt that add to your assessable income each financial year. ‘Deductible debts’ can include investment loans for property, shares and managed funds. Also, the cost of borrowing needs to exceed the income for the asset to provide a tax advantage.
Common ‘non-deductible debts’ include credit cards, home loans and some personal debts.
Prioritise and manage repayments
A recurring question we are asked is, ‘what should be paid off first and why?’ It’s an understandable quandary. If you are battling with credit cards, personal loans, investment loans and store cards, it’s difficult to know where to start.
Credit cards are often an issue for people because of the high interest rates charged by lenders. If you have more than one card, you should consider paying off the one with the highest interest rate first and look at paying above the minimum required amount. This can slash the interest you pay and the time it takes to repay the debt. Depending on your situation, you could also consider consolidating your credit card debts using a personal loan. Once your credit card debt is repaid, you could cancel all but one card. It’s best to avoid cash advances (because there is no interest free period and there may be cash advance fees), maintain a low credit limit (don’t accept unnecessary increases) and cut back on extras (such as loyalty programs).
What about your mortgage? Is refinancing an option?
Banks that are experiencing large increases in their cost of funds may be passing on these costs to borrowers. In other words, refinancing may save you interest. If you have a loan more than three or four years old, it’s worth re-evaluating your situation as a newer product may better suit your situation. Also, don’t expect the bank to come knocking with a new deal – you will generally need to initiate the inquiry.
If you are worried about the risk of your variable rate loan increasing, consider a fixed rate loan for comfort of certainty. Servicing a mortgage, particularly in the first few years, can be hard work. If meeting principal and interest payments is too heavy a burden, think about converting your loan to interest only payments to ease the load for a short period. Another option if you’re really stretched is to refinance a 25 year loan to over 30 years. This will reduce your monthly commitments but ask your lender about the drawbacks of this approach too.
Stay committed
At the heart of successful debt management is a solid budget. Putting a budget in place can give you an enormous sense of satisfaction and peace of mind that you’re bringing your finances under control. Budgets however, take commitment and discipline. Be sure to set realistic goals for your budget, don’t stray from your goals and don’t give up if you overspend. It’s ok to fine tune.
A licensed or appropriately qualified financial adviser can help you put in place an action plan for tackling debt through a budget. They will also provide advice on wealth protection, which is often overlooked by well-intentioned Australians who are trying to manage debt repayments but struggle if they become incapacitated and unable to earn an income.
Like some advice?
Mercer financial advisers can assist you to develop a financial plan to help you get on top of your finances. To make an appointment to discuss your needs, please contact us on
1800 633 403. The initial consultation is free of charge.
We also have specialist lending advisers who can assist you to find home loans with a lower interest rate. This service is provided at no cost to you. Find out more about our mortgage lending service here.
More information
understandingmoney.gov.au
fido.gov.au
This information has been prepared by Mercer (Australia) Pty Ltd ABN 32 005 315 917 for general information only. The information does not take into account your personal objectives, financial situation or needs. Therefore, you should not act on this information if you have not considered the appropriateness of this information to your personal objectives, financial situation and needs. You should consult a licensed or appropriately authorised financial adviser before making any investment decision.
