Busting post-Christmas debt

Money and Life
(Financial Planning Association of Australia)

Feeling financially fragile after spending big during the festive season? Learn about the pros and cons of different approaches to paying off credit card balances in our comprehensive debt-busting guide.

Even if you’re usually disciplined about spending, Christmas can be a time when your budget goes out the window. If you’ve ended up with a debt hangover thanks to festive expenses, you may have some unpaid credit card balances to deal with. So what can you do to minimise the impact of these debts on your finances in the year to come?


Making good your bad debts

When it comes to owing money, not all debts are a problem. A mortgage is generally seen as ‘good’ debt as you’re paying for a roof over your head and to own an asset that can grow in value over time. Borrowing money on credit cards or through personal loans, on the other hand, is considered bad debt. Whether you use a loan to buy a car or your credit card to upgrade your laptop, you’re paying for something that has less value over time.

The other reason why personal borrowing becomes a burden is the high interest rates, particularly for credit cards. When you’re paying double digit rates, a larger proportion of repayments go towards interest instead of paying down the amount you originally borrowed.

There are a number of ways to go about paying a lower rate of interest on the amount you owe, each with their pros and cons.


Personal or home loan

If you have multiple credit card balances, store cards or loans, you could look at taking out a single personal loan to clear these debts in one go. If you have enough equity in the property you currently own, you may be able to refinance your home loan to consolidate your personal debts into your mortgage instead.

Pros

– Done right, debt consolidation will leave you with a single repayment to manage going forward. This can make it easier to commit to one payment each month that moves you towards becoming debt-free. When you consolidate your debts using your home loan, it’s as simple as making a mortgage payment each month.

– Finding a loan with a relatively low rate of interest can also reduce the amount of interest your total debt is accumulating from month to month. When you refinance your home loan to consolidate personal debt, you’re likely to benefit from the lowest possible rate of interest on what you owe.

– If you’re only paying the minimum amount required each month on your credit balance, it could take you decades to pay back what you owe. Taking out a loan with a fixed term instead can force you to repay the amount in full over a shorter period of time.

Cons

– Credit cards are designed to be used for short-term borrowing. If you transfer a credit card balance on to your home loan, you could be paying back money spent on a new TV or grocery bills for the next 30 years. In doing so, you’ll pay a hefty sum in interest on your borrowing overall, even though the rate is lower.

– There may be fees and charges associated with borrowing for debt consolidation, whether it’s a personal loan or a mortgage. You’ll need to be sure any savings on interest paid aren’t outweighed by these costs.


Balance transfers

There is a wide choice of credit cards available offering 0% interest on balance transfers from an existing credit card for a limited time, usually six months or more. Once this introductory offer period is over, any remaining balance on the card will revert to a standard advertised rate. Canstar and Finder both offer information about current balance transfer offers from banks and other credit card providers.

Pros

– When you have a temporary debt to clear and have money available in your cash flow to pay it off in a matter of months, a balance transfer offer can be a great way to stop your debt from growing during this time.

Cons

– Some balance transfer cards may charge a percentage fee for the amount you transfer from another credit card or loan. Others may come with annual fees or other charges. Make sure you take these costs into account when calculating how much you could save with a balance transfer card.

– Having your application accepted for a balance transfer credit card will depend on your credit score. If you’ve had problems repaying debts or loans in the past, and this is reflected in your credit history, you may not be successful in applying for a new credit card.

– Any purchases you make using your new card will attract interest. So if you spend more money on your new card, or keep spending money on your old card, you’ll be building up more debt that’s liable for interest.


What about Afterpay?

In November 2018, ASIC released a report on the ‘buy now, pay later’ industrywhich is fast becoming a popular alternative to credit cards as a way of borrowing. Afterpay is probably the most common provider of this service, along with other companies such as zipPay, Certegy Ezi-Pay, Oxipay, BrightePay and Openpay. According to the report there was $903m in outstanding buy now pay later balances at the end of the 2017/18 financial year. One in six users become overdrawn, delayed bill payments or borrowed additional money because of a buy now pay later arrangement.

Unlike credit card providers, most buy now pay later services do not check your credit history or ability to make repayments[1]. If you’re unable to stick to your repayment schedule, you’ll be liable for late fees. Some providers also charge monthly account fees and for payment processing. What seems to be an easy and low-cost way to borrow can quickly become very expensive.


Address the causes of your debts

Whatever solution you use to deal with your debts, the relief on your finances is likely to be temporary if you don’t change your spending habits. When you take steps to reduce the interest owing on your debt, it can make extra borrowing seem more affordable. But it’s all money you’ll need to pay back eventually.

Services like Afterpay make it easier than ever to buy things that we don’t have the money to pay for right now. If you make a habit of borrowing to pay for something that’s actually beyond your budget, perhaps it’s time to rethink your mindset around money and taking on debts.


Get professional help

Before taking any steps to change the way you manage your debts, it’s a good idea to contact a financial counsellor for a free consultation. They can review your financial situation and budget, negotiate repayment arrangements with creditors and explain your different options if you’re struggling to make repayments.

National Debt Helpline

Financial Counselling Australia

Looking for ways to get your budget under control? Discover seven mind hacks for spending less.

References

[1] MoneySmart, Buy now pay later services, “Most buy now pay later providers do not check your ability to make repayments or your credit history. This means you could end up taking on more credit than you can afford and could have trouble making your repayments.”https://www.moneysmart.gov.au/borrowing-and-credit/other-types-of-credit/buy-now-pay-later-services

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