Australian households owed $2.472 trillion at the end of September 2019, according to the Reserve Bank of Australia (Statistical Tables E01), and our debt levels aren’t falling away. On the bright side, our levels of net worth have more than recovered after the global financial crisis, meaning we are slowly paying down our debt levels.
The question remains, however, whether households are paying down their debt in a smart way, People’s Choice Spokesperson Stuart Symons says.
“We use debt to help us buy homes, cars, holidays and even to help us through tough times, but sometimes we don’t look critically at our debts when we pay them down,” he said. “Understanding the quality of your debt can really pay off by improving your financial position.”
1. Don’t flinch away from the facts
“Getting a full understanding of where you stand is essential. Get a full list of the balance, interest rate and the due date of each facility, and perhaps even the reason why you have the debt,” Mr Symons said.
“You may have signed up for a credit card to build points, but if the points are no longer worth it, then you’re possibly paying for something that no longer holds value for you.
“Just don’t flinch away from the facts. It’s better to know what you face so you can work on it constructively rather than shy away and continue to deal with the consequences."
2. Not all debt is evil
Understanding the purpose of each debt is vital – especially if some are connected to earning an income, Mr Symons said.
“Debts relating to the earning of income may produce tax deductions for the interest you pay on them. If this is the case, then those debts can be considered cheaper than debts with the same interest rate, term and fees – after all, you may be receiving money back for it at tax time,” he said.
“So always ask whether each debt is income-producing, because not all debt is evil.”
3. Your debt hit-list
Listing how much each debt costs you every week or month can be both scary and tedious, but it will also highlight just where your debt is hurting you most, Mr Symons said.
“Ranking your debts according to how they eat away at your hard-earned income will reveal the basis of where you stand and the next steps. It’s a good way to develop a debt hit-list that can help you remember the positive difference it will make once you have paid each debt off,” he said.
“It’s generally best to pay down your more expensive, non-deductible debt first. These are the debts that do nothing except eat away at your income. Dead credit cards with debts that roll over from one month to the next are a good example – pay them down if they are doing nothing in your life.
“At the other end of the scale are those debts that are relatively cheap, despite their high balances. Your home loan is one example. It is likely to be your highest debt and you are likely to pay more in interest than any other debt – but it is extremely cheap at the moment, so it doesn’t need to be targeted for an extreme makeover.
“HECS debts should sit towards the bottom of your list. They are long-term debts with very, very low interest rates and very favourable repayment terms. They can wait.”
4. Put the hard word on your debt
“Look at your debt list and ask yourself whether you need the facilities you have,” Mr Symons said. “Some may have outlived their usefulness, or you may now have access to facilities that are cheaper or better suited to what you now need.”
5. Take a breath and consolidate
If you have pared back your debts to the essentials, you are in an excellent position to start being smart about how you manage the future.
“It is worth asking whether it is worth transferring all remaining debt to a lower-cost facility like a home loan. Given interest rates have dropped significantly, reviewing your finances may open up the possibility that a single personal loan can be used to cover all existing debts if you don’t have a home loan,” Mr Symons said.
“In either case, this is only a solution is you have the discipline to avoid creating new debts. Consolidation works by lowering the cost of your overall payments – and the time you spend making those payments – but if you start accruing more debt on a new credit card or a buy-now-pay-later scheme, you are actually increasing your exposure.”
6. Make use of each time bonus
Simplifying your debts may have an added bonus, Mr Symons said.
“Consolidating your finances is likely to cut the time you need to spend managing them, which has to be a positive,” he said.
“But think about using that saved time as an investment. Set aside some time to look for how you can save through lower fees, or by reviewing your insurance or a better energy provider. If you can dedicate that small amount of time to improving your position, then that investment is likely to compound the benefits you receive over the years.”
7. Capitalise on your hard work
“If you’ve helped cut Australia’s household debt levels from $2.5 trillion by looking to your own finances, then now is the time to push it further,” Mr Symons said.
“Budget for cutting your debt further or changing its structure to work better for you. Whether you turn to a spreadsheet, an app or a whiteboard, there are tools available to make this work for you.”