6 Tips for Better Debt Management
Did you know that a $450,000 mortgage with an interest rate of 3.9%pa costs $314,102 in interest over the 30 year term of the loan??
Getting a handle on your debts can be the first step to financial freedom and knowing that all debts are not created equal and structuring your debts to minimize the amount of money they will cost you is an important first step to better debt management.
We have included below 6 tips to better debt management.
1. Debt Consolidation – you may have equity in your home that is enough to consolidate smaller debts into without breaching your 80% loan to value ratio. Your home loan interest rate is much lower than a credit card. For example, if you owe $10,000 on a credit card with an interest rate of 22% that’s $2,200 pa the bank is charging in interest costs, if you owe an extra $10,000 on your home loan with an interest rate of 3.9%pa the cost of servicing the debt is $390 pa. A saving of $1,810 pa. If you consolidate ensure you up the repayments of your home loan to smash the additional funds as soon as possible.
2. Pay off the highest interest rate first – if debt consolidation is not an option, paying off the most expensive debt first is the next best strategy. Generally, credit cards have a high rate, then unsecured personal loans, followed by car loans and then your home loan. An exception to this rule is if you have an investment loan as the interest rate is tax deductible.
3. Change your repayments to fortnightly – by making 26 payments per annum at half the amount of your monthly repayment you will be making additional repayments and saving interest costs and this alone will save you a few years off the term of your mortgage.
4. Debt recycling – if you have an investment loan and a home mortgage you can elect to reduce the payments on your tax effective investment loan and use the extra funds to pay off your mortgage sooner as a non-deductible debt your home loan costs you more. This can have a huge impact on term of your loan, the accrued interest costs and the tax savings.
5. Avoid short term high interest debts – credit cards, car loans and personal loans are high interest and not secured against an asset that increases in value. The cost to service these debts far outweigh the value of the items you purchase. Putting in place a sound budget and saving for cars and holidays (if you have a home loan these savings can accumulate in your redraw) is the most financially savvy option.
6. Redraw and offset facilities – maximise the facilities available on your home loan packages. Redraws are often underutilised. By creating a budget and moving money that does not need to be used for day to day expenses to your redraw you get the money out of your easy to access debit account whilst still offsetting your interest costs.
All loan products vary so it’s important to look your home loan. Your provider may offer a flexible redraw facility with no restrictions on transferring or you may be able to get access to more than one offset account.
Any money within the offset and redraw facilities reduce the interest you pay on your home loan. As your home loan is not tax deductible the interest costs are paid for with your after-tax dollars, for example, if your home loan balance is $450,000 and the rate is 3.9% and your marginal tax rate is 39% (including medicare levy) you have to earn $28,770 pre-tax to repay the $17,550 pa in interest costs.
This means an alternative investment would have to return over 6.39%pa guaranteed to be better off than repaying your mortgage and accumulating funds in an offset or redraw facility!
Please note this is general in nature and not specific to your personal circumstances, as a result it does not constitute personal advice and should not be acted upon. It is important to seek personalised financial advice that takes into account your individual circumstances.
Please contact us to discuss your personalised debt management plan!