Smarter Debt Reduction

Welcome to February! We’re currently looking at debt reduction.

The problem with debt is that you’ve already had the excitement of spending the money; now you’re faced with the pain of paying for it! It’s hard to get excited about getting up in the morning and going to work to pay for a thrill you’ve already had!

Last week I asked you to decide your debt rules. Hopefully you made a rule to never borrow for a holiday or anything else that does not give you an ongoing benefit every day. Not too far down the track you’ll be so stressed over making the repayments you’ll be longing for a holiday!

Today we’re up to Step 2 and we’re going to look at your options for speeding up the debt repayment process.

Step 2 – Smart Debt Reduction

There is no rocket science to debt reduction. If you want to pay debt off faster, the smartest and most obvious strategies are:-

• Increase the regular repayment amount
• Decrease the interest rate
• Sell some non-essential items and make lump sum debt reductions
• Stop digging the hole deeper (that’s why we made our rules last week!)

If you have more than one debt you need to add the following to the list above

• Increase the repayments on your highest interest rate debt in preference to your lower interest rate debts.

• Prioritise paying off non tax deductible debt in preference to tax deductible debt which will at least give you the benefit of paying less tax.

It can get complicated if you have to choose between options that are not so clear.

E.g. do you focus on paying off a non-tax deducible debt when it isn’t the highest interest rate debt?

If you have complexities, I recommend you talk to you mortgage broker and accountant and get them to work together on your most effective debt reduction plan. If you don’t have anyone you normally trust with stuff like this shoot me an e-mail and I’ll give you some options.

Today let’s keep it simple.

If you have a mortgage and haven’t reviewed it in the last 12 months you can probably refinance to a lower interest rate.

PROS… A lower rate can mean lower repayments or a shorter loan timeframe.

CONS… Sometimes the costs involved can cancel out the benefit. Don’t forget: add the cost for swapping banks to the new loan.

TRAPS… If you have just spent 5 years paying off a 20yr mortgage and are offered a new 20yr mortgage with lower repayments there is no magic in that. You just made your original loan a 25yr loan so of course repayments will be lower!

TIPS…. If you refinance to a lower interest rate, make the same repayments you were making on the previous loan. You will get ahead on your payments and get out of debt faster.

Currently 4% is possible for a home loan. How much are you paying?

If you would like to work out if there really would be a benefit in renegotiating your mortgage I created a simple online excel based calculator just for today’s message so make use of it. It’s at www.simplybudgets.com.au/calculators/refinance-calc.xlsx

There is one box where you are asked to enter the cost of re-financing. My personal mortgage broker suggested $750 is a reasonable estimate to enter there for a standard bank swap. If you have a fixed interest rate with your current bank there may well be other charges as well so you will need to find out and add that as well.

You need to know how many months you have been paying off your current loan and what the current balance is.

Here is an example of what it can do…

Refinance-Figures

A $350,000 mortgage that has been going for 3 years at 5.25%

Currently it still has 22 years to go. Refinanced to 4% that comes down to 18 ½ years if the repayment is maintained at the same level as at 5.25%. I encourage you to experiment with the ‘New Repayment Amount’ and see what impact a few dollars extra can make.

If you have other higher interest rate debts as well as a mortgage and you reduce the interest rate on your mortgage you might want to consider the option of reducing your mortgage repayments and increasing the amount you pay off any higher interest rate debts.

If you have multiple debts my debtbuster software was specifically designed to help you work out the best way to allocate your debt repayment dollars to get the best outcome over time.

Next time we’ll look at more strategies.

Just recapping for today…

See if you can get a better interest rate on your mortgage. Right now is a perfect time to be shopping for lower interest rates.

If you don’t have a mortgage but you do have unsecured debts such as Credit Card debt look at options to refinance that to a lower interest rate. Maybe a personal loan with a Credit Union would be an option for you to look into.

That’s all for now.

David Wright