You need to understand your debts to be able to come up with an effective personal debt reduction strategy.
Debts are simply amounts of money that you owe to a financial institution – whether that be a bank or non-bank lender.
Debts can arise from personal loans, house loans, credit cards and in-store finance cards.
The cost of the debt
to you comes from the interest rate of the loan or credit card. For example, if you have a personal loan for $10,000 at an
interest rate of 12%pa, every year you pay 12% of the amount remaining on the loan to the lender - $1200 in this case.
This is the cost of the loan to you. The higher the interest rate on the loan or credit card, the higher the cost
to you.
In general, house loans have the lowest interest rate because you typically borrow a large amount. Personal
loans are next followed by credit cards and in-store cards – and some of these have interest rates in excess of 20%!
In understanding your debts, it’s also important to understand who the debt is with.
Banks are
the most conservative in issuing loans, as they consider your ability to repay’ in their assessment of your loan application.
If they don’t think you can repay the loan, they won’t give it to you!
If you are in this situation,
be very very careful about getting a loan for the same amount from a non-bank lender as they are less concerned with your
ability to repay – there are more repossessions from non-bank lenders for this very reason!
Prioritise your debt
reduction
Debts with a higher interest rate cost you more money than those with a low interest rate.
Your
priority for debt reduction therefore needs to be to pay off the loans with high interest rates first. And these loans are
usually for bad loans, since lenders won’t give good rates where these is no asset they can repossess if you fail to
make payments.
This usually means pay off your credit card and in-store cards first, then personal loans (including
car loans) and then house loans. Business loans, particularly if there is a tax off-set allowed, can be paid off last provided
the ‘business’ is in good shape!
A note regarding the in-store loans where they offer no interest,
no repayments for 12 months or so: These are useful forms of credit if you manage them properly. And the way to do that is
make sure you pay the loan off over the “no repayment” period. For example, if you take one of these loans out
for $1200 for a 12 month period, every month pay off $100 from the loan. That way when the interest kicks in {and this interest
rate is usually high}, you’ve paid it off anyway.
There is a debt record sheet in the
ToolBOX under the section on Financial Tools you can use to track your debts. You can also use the Saving Plan in the ToolBOX as
part of your debt reduction strategy.
When you’re out of your depth
When you are truly out of your depth when
if comes to sorting out your debt then get urgent financial advice from a
debt counselor. Too many people think that they can solve all their problems themselves – but it’s important to know when it’s
time to get help.
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