Now What – Getting Debt Free

Last weeks email struck a chord with a few of our clients. Hard facts do tend to spark thought and reflection in people, and that certainly was the desired effect. If we are to set about truly helping our clients to manage their money better, become debt free and ultimately improve their wealth – then hard and fast facts must be shared.

We spoke about the impact of credit card debt on household living expenses and the dangers of letting these facilities spiral out of control. At some point, a consistently ‘maxed out’ credit card becomes what bank term as Hardcore Debt. This means the card balance is not being actively reduced.

Repayments are made, then the money that was paid is re-spent again, creating a cycle of spend, re-pay, spend. When debt becomes hardcore, it becomes a serious problem – especially if spread over more than one card. The issue is far greater than the debt issue alone.

Take a look at this simple calculation:

43 years to be free of a $10,000 debt – that’s longer than a Mortgage term!).

In the current lending climate, banks look very closely at customers spending habits. If a card is continually cycling through hardcore debt, it’s very likely that a bank will decline a home loan based on debt exposure and poor credit management.

Following Step 1 from last week (cut those cards up! Burn them!), where we prevent the cards from being used.

Step 2 involves making serious efforts to pay the cards off, fast. Again, if we go back to that $10,000 card, paying only the minimums (43 years!), it becomes quite apparent that min-repayments simply won’t help you out of debt.

Using that common example, if you paid $200 more each month in addition to the minimum required, then you will save yourself about $23,000 in interest and will have it paid off in almost 7 years. That’s much better than 43 years, but it’s still a long time. If you double that extra repayment to $400 each month, you bring that term down to just over 2.5 years and save yourself more interest still.

There are numerous strategies to tackle this, and what works for you may not work for someone else – you have to consider what is the most realistic and sustainable option for you. Regardless of which strategy you deploy, a behavioural change is still necessary.

With the card(s) now burnt at the stake, it’s time to work out some figures: what can you afford to repay on that card to bring it down. This requires everyone’s least favourite pastime: budgeting (except us, we love helping clients with this).

Once you have decided what you can afford to pay into that card (we highly recommend playing with this calculator- it is very satisfying!), it’s time to set up an automated payment system. In some ways, credit cards are designed to be ‘forgotten’.

They just tick away in the background while you bleed interest to the banks. Setting up a recurring Direct Debit each month means you are in control of those repayments; you are actively paying the card down, and you don’t have to do a thing (OK, you have to set the DD up first, but that takes all of 2 minutes).

If a large chunk coming out of your account each month makes you cringe, then split the payments up and pay them weekly or fortnightly, so it doesn’t look quite as scary. You could even line up the repayments with your wage, so it is taken straight out the moment your pay goes in – as long as it’s automated, it really doesn’t matter how often you pay them.

Be mindful that you must make sure that at the very least your minimum monthly repayment has been paid onto the card before the actual due date – we can also help explain this further as we have seen people caught out by this one.

This is just a simple example of how effective paying more off your card can be. But what if you, like so many Australians, have more than one card. And worse, they are all plugged into that hardcore debt cycle?

Again there are plenty of options. It makes sense though, to focus on the card that incurs the highest interest. That sucker is burning a hole in your ability to save money. By eliminating that card first, you save yourself a lot of interest, and once the card is paid out in full, you can direct your attention to the next card.

Another option is to pay off the card with the smallest debt owing first. It will take less time than larger cards, and once paid off you can direct those repayments onto the other card(s). This is actually part of a larger debt strategy, which we have mentioned previously: Snowballing (read more on that here).

There are plenty of apps available to help you with this, and it is very satisfying to see exactly when you could be debt free!

It’s more about behaviour modification than hard figures – changing the way you look at becoming debt free and showing you how quickly you can do it by simply budgeting better and having great discipline. This is a DLS favourite for debt free planning.

With both options, as you make significant progress in paying off the card(s), you should also call the card provider, and have your limit reduced. Remember this is about changing behaviour, so we don’t want to leave a large limit sitting there – it’s too tempting and too risky.

A quick phone call (a lot of lenders actually allow you to do this online now through internet banking) will have that limit dropped, and you continue doing this until it’s completely paid off.

Ok, this all sounds pretty exciting, right?

And we are playing with numbers, but in reality, you may not have the dollars available to pay off more on those nasty cards. That is a reality for many Australian families. They are trapped so deep in that hardcore debt cycle, that they are barely getting by each month. Or, maybe they are surviving, but multiple repayments on multiple cards can be a pain to manage (although automation does help) and sometimes you just want the bloody things gone.

Consolidating debt has now become a very viable option for credit card debt. Yes, it is another loan, but you are placing all that debt into one amortising facility that has a fixed repayment and term which guarantees a payout date. You still have to meet your payment obligations, but it can be far more manageable. This is about tidying up your finances and giving yourself the opportunity to shed the debt and start saving and breathing.

Let’s quickly recap where we are at so far:

Get rid of the cards. Destroy them so they cannot be used.

Calculate how much you can afford to repay, above the minimums.

Set up automatic payments according to your budget and pay-day. Pick a strategy that suits your needs.

If you need help with any of the above or want to talk in more detail about strategies, please email or call DLS – we love helping our clients get free of debt!

Disclaimer: We have used basic examples here, simply to illustrate our point, using publicly available information using the Australian Government’s moneysmart calculator.

Your full financial situation and commitments need to be considered prior to any offer and acceptance of a loan product.

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