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Module 2: How to manage debt well

“It’s not about having lots of money, it’s about how you manage it.” 

Introduction 

Like everything in life, debt is much easier to manage with the right strategy in place. However, most people don’t enjoy talking about their finances and therefore, avoid the topic. One in five Australians prefer not to talk about money to their partner, friends and relatives. Shocking, right?! Let’s start an open dialogue about debt and what strategies there are to manage it well. 

Ideally, you want to be thinking about this before taking on debt. However, life doesn’t always go to plan and you may be knees deep in debt already. If you have the vague feeling you should’ve paid more attention when they taught maths in school be reassured: most people only learn how to manage their finances at some point in their adult life or not at all. 73% of Australians don’t even know their credit scores.

In this lesson, you will learn: 

  • Why you should have a strategic approach; 
  • How to know where you’re at with your finances; 
  • What methods you can use to minimise debt; 
  • How to keep track of your repayments and your remaining debt amount. 

Step 1: Know where you’re at 

Taking a closer look at your debt and financial health may feel uncomfortable at first. However, you will only be able to evaluate the situation once you understand how much debt you have and how much spare cash is left after all your obligations. 

Your credit reports list all your current credit accounts, as well as some of your past credit accounts – maybe even some that you forgot about. Your credit report may include mortgages, credit cards, personal loans, business loans under your name and even in-store credit cards. However, if you owe relatives or friends, this won’t be listed in your credit report. 

Different types of debt 

There are different reasons that may have caused you to be in debt. Is your debt due to: 

  • Assets. You may have made a big purchase like a car or even a home and now you are paying it back. 
  • Circumstances that are out of your control such as unexpected medical bills, a divorce, unemployment etc. 
  • Your spending habits. If you constantly need to borrow money to afford your lifestyle, you may be living above your means. Are your spending habits matching your income? There may be a problem if you spend too much money on things you want and then don’t have enough for your actual needs like rent, groceries and so on. 

Know your income vs your outgoings

Once you know your debts, you should have a closer look at your income and expenses. How much are you earning each month and how much are you spending? At what time of the month are you billed for each? 

This includes:

  • Your income; 
  • Debt repayments; 
  • Rent; 
  • Electricity 
  • Phone bills; 
  • Transport (public transport and anything you pay for your car including fuel);
  • Sports and hobbies;
  • Credit cards; 
  • Subscriptions (t such as Spotify and Netflix);
  • Any additional bills.

Step 2: Prioritise your debts

While we at Tippla will always do our best to provide you with the information you need to financially thrive, it’s important to note that we’re not debt counsellors, nor do we provide financial advice. Be sure to speak to your financial services professional before making any decisions. You can find more information on prioritising debts on the National Debt Hotline website

With a strategic approach, you don’t necessarily want to just increase your repayments for all debts. There are better ways to structure your repayments. If you do have spare money to pay towards your debt, it might be beneficial to prioritise which you want to get rid of first and pay towards them with more financial power. 

But how to know which ones to choose first? While all debt is important, some may have serious legal implications and should be rated higher on your priority list. Car loans are often secured against the car you have purchased. Therefore, not being able to repay this loan may mean that you lose your asset. Additionally, some loans have higher interest rates than others. You may be saving money in the long run if you pay higher interest loans off first and then put your energy into the others. 

Step 3: Choose your method to reduce debt 

There are two main methods to reduce your debt. Here is a breakdown of the two:

Snowball system 

This is how the snowball system works. Look at your list of debts and organise them from the biggest to smallest amount. Make minimum payments towards all other debts and increase the amount for your smallest. Your goal is to pay off this one as quickly as comfortably possible. Once it is paid off, move the remaining amount from your debt budget towards the second smallest debt. 

If you need to see results quickly, this method might be the most rewarding and effective for you. If you need to see the effect of your actions to stay motivated, this could be a great way to reduce your debt.

Avalanche system 

The avalanche system has the same initial approach: look at the list of debts but organise them from highest to lowest interest instead. If you mean to save money, this method could do the trick. Choose the debt with the highest interest rate. The longer you keep high-interest debt, the more it might cost you. Make the minimum repayments towards all other debts and increase the amount for your highest interest debt. While this may take a little longer, it could be very rewarding in the long run. Once this debt is paid off, your freed budget could be much bigger and can be put towards the second highest interest-debt.

Refinance 

Credit offers change all the time and sometimes, a better option may be available while you are still repaying your old debt. In some cases, refinancing a loan under better conditions could end up being smarter and cheaper for you. 

Refinancing, as the name suggests, is when you finance something again. Typically this is done with new loans at a lower rate of interest. It is common for people to refinance their mortgage. 

In essence, this basically means you trade in your old mortgage for a new one – sometimes at a new balance. When you’re refinancing your mortgage, your bank or lender pays off your previous mortgage with the new one. However, it is possible to refinance more than just your mortgage.

The benefits of refinancing include a better interest rate which means lower monthly repayments, shortening your loan term, consolidating your debts and more!

Debt consolidation 

If you have accumulated debt from multiple sources, you may be able to consolidate them into one loan. This may save you money as you only pay interest on one loan and could make it easier to manage your repayments. Instead of remembering multiple dates, you only need to keep track of one. 

The benefits of debt consolidation are numerous, such as simplifying your repayments, reducing your cost to maintain your debts and having more control over when you can become debt-free.

However, before consolidating your debt, there are a number of things you should consider and check first. Whilst there are numerous benefits to consolidating your debts, sometimes, it may cost you more if you end up with a higher interest rate or have to pay fees.

You should compare the interest rate of the new loan, and find out whether there are any fees or additional costs, against your current loans. If the new consolidated loan ends up being more expensive than your current loans, then it might not be worth it and better to keep things as they are!

Some fees you should keep an eye out for include: penalties for paying off your original loans early, application fees, legal fees, valuation fees and stamp duty. 

Another thing to watch out for is switching to a loan with a longer-term. Although the interest rate might be lower than what you’re currently paying, if you have a longer repayment period, then you might end up paying more in interest and fees in the long run!

Tippla is a tool that helps Australians to access and understand their credit scores. We are not financial advisors. We work with a range of industry professionals and compliance check our content to ensure factual accuracy. We do not provide professional financial advice. Consider seeking independent legal, financial, taxation or other advice to check how the information in this lesson relates to your unique circumstances.

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