Reducing debt is easy in theory but exceedingly difficult in practice. We all need to borrow money at some point in time, whether it is to buy a house, buy a car or start a business. Reducing your debt provides savings because you pay less interest. Once your debts have been repaid, you will be able to increase your wealth by saving the repayment amount which then will be available to put towards wealth creation.
The cost of debt includes the interest you pay over the life of the loan and loan fees. Reducing these costs can provide you with significant savings which can help you reduce your debts quicker and increase your capacity to save.
Here are some strategies to get on top of your debts:
Know what you owe to get a clear picture of your total debt. Make a list of all current loans, outstanding balances, and interest rates - this includes credit cards, personal loans, consumer leases, and home loan. Add up all the debts to see how much you owe in total. It may be a shock, but this is the first step to taking charge of your money. Also, work out your total weekly spend on debt and interest paid.
Contact each lender and ask them for a better interest rate. If you don't have any luck, look at refinancing but make sure that you negotiate a loan with a similar term to what you currently have as some lenders will only refinance to a 25 to 30 year loan, longer that what is currently remaining meaning more interest again. Mortgage broker or comparison websites can help you find what is available. Look out for any fees or charges from refinancing eg break fees, termination fees, from your current lender and application fees and stamp duty from your new lender.
Consolidating your debts including credit cards and personal loans, into one loan can reduce account fees to just one loan and reduce the total amount to repay the debt as the new consolidated amount now is charged interest at the lowest interest rate. This generally should be your home loan. The strategy requires increasing your home loan facility, with the additional funds borrowed then used to pay out the other debts. After the consolidation, continue making the same overall loan repayment as you did prior to make sure you pay off the debt quicker and further reduce the interest owing.
If you aren't able to consolidate your debts, make sure that you repay the loan with the high interest rate first, so look at making extra payments when you can to this debt first.
Making extra repayments on your loan can help eliminate your debt faster and save on interest costs. Even a small increase in your repayments can provide you with significant savings over the life of your loan. Any lump sums you receive, such as tax refunds or bonuses, could be directed to your loan.
Putting your additional repayments into an offset account or redraw facility gives you the benefit of the reduced interest cost plus the security of knowing you can access the money again if you really need it. If your loan doesn’t have an offset account or a redraw facility, it may be worth checking with your lender to find out if this feature can be added to your existing loan.
Repaying non-deductible debt first ie loans taken out to buy a non-income producing asset, such as your home or private car, or to pay for personal expenditure, such as a holiday. You are not eligible for an income tax deduction for the interest on these loans so these debts should be repaid as quickly as possible. Loans that are used to buy an income-producing asset (such as shares or an investment property or for your business) are called 'deductible debt'. The interest on these loans are tax deductible, which effectively reduces the cost of the debt, with the value of the deduction being higher if you are on a higher marginal tax rate. Speed up the repayment of non-deductible debts by:
using surplus income to make additional repayments.
make more regular loan repayments eg if repayments are monthly, change to fortnightly which results in making 26 repayments for the year, equating to 13 months instead of only 12 and will shorten the loan term.
change the repayments on your deductible debt to 'interest only' (if currently principal and interest loan) and direct surplus funds to repay your non-deductible debt quicker.
be aware that with interest-only loans, you only pay the interest on the amount you've borrowed ie your principal does not reduce during the interest-only period. So once you have cleared you non-deductible debt, then focus on paying your deductible debts.
Look for any loans you might be able to remove immediately e.g a car lease look for a more affordable vehicle that you can purchase outright .
Consequences
Before making any changes to your loan, you should check what fees and penalties may apply.
Some loans do not allow additional repayments to be made. You should check with your loan provider whether additional repayments are allowed and whether any penalties apply.
You should have adequate life insurance to help meet loan repayments if your income stops because of death or illness.
You should check with your accountant before making changes to investment related borrowings.
General Advice Disclaimer
All of the material published on this website is for information purposes only and does not constitute advice. This information is of a general nature only and has been provided without taking account of your objectives, financial situation or needs. Because of this, we recommend you consider, with or without the assistance of a Financial Adviser, whether the information is appropriate in light of your particular needs and circumstances.
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