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Thursday, December 15, 2011

Ten Tips for Managing Debt (with a little bit of interest)

January is often a month when you look at the credit card statement and after a quick panic decide to do something about your debt position. To get you off to a good start here are ten quick and easy tips.

1. Draw up a budget: It seems an obvious step, but few people do it effectively. Knowing what you spend and what you earn, and the difference between the two is a real leveller. Detail essential and non-essential expenditure. Decide how much you will save and how often. If you fall short on meeting bills and debt repayments, you'll know something's got to give on the outgoing side. Start to cut back on the non-essential expenditure. The reduction may only be for a limited period of time, until your debts get under control.

2. Keep some emergency money aside: While you may be juggling your finances to meet all of your commitments, make sure you have a small cash reserve, usually two months expenses at least, for unforeseen circumstances. This will protect you from being forced to accept costly, short-term lending arrangements. It is widely held that an adequate emergency cash reserve should be in the order of $10,000. This could be held in your mortgage as advance payments if it was immediately available on demand.

3. Use a Cash Management Trust: Set up your income flow, including your salary, interest and dividends from investments and rental income, to be paid into the one CMT. Organise then for all debts to be paid from the account automatically. Most CMT's can cater for this. It takes the worry out of paying things on time. The CMT may require an initial $5,000; but then you can’t let the balance drop below $1,000. You’ll pay the manager a fee of the net value of the funds, but the net interest you’ll receive will be much higher than that offered on most standard deposit accounts.

4.      Use taxation benefits: While tax alone is the wrong reason on which to base investment decisions, it should certainly be a consideration, particularly in light of recent Government initiatives to encourage saving and investment by Australians. The change in the treatment of capital gains tax is one way investors can increase returns after holding an investment for at least 12 months. Increased after-tax returns can help repay debt.

5. Be smart with lump sums: You may be tempted on receiving a lump-sum payment like a tax return, inheritance or windfall gain to take that much-deserved holiday, new wardrobe or buy the latest Lotus. Don't. The short-term satisfaction won't last, particularly with debt collectors at your door. Use the money to reduce your debt to more manageable levels or invest half for the longer term.

6. Pay your debts automatically: Talk to your employer to see whether you can have your salary paid into multiple accounts, including your debt accounts. The obvious benefits here are that your income flows will be better managed and the money disappears before you get it, thus reducing the temptation to spend more instead of repaying debt. Alternatively, have set amounts deducted from a nominated account to automatically pay outstanding debts. The essential point here is to make sure you have enough money in the account when the deduction falls due, otherwise your bank will hit you with a nasty fee for dishonouring the arrangement. Banks normally have a minimum account balance of, say, $500. Below this an account-keeping fee is charged.

7. Get smart with credit: If used wisely, credit cards and lines of credit can get you ahead at a low interest cost. Pay all of your income into your line of credit mortgage and use your credit card to pay all your bills and outgoings. Then, just before the interest-free period on the card ends, draw down from your line of credit to pay the card bill. The danger here, of course, is that you spend too freely on clothes, restaurant meals and other non-essentials, and you effectively pay for it with equity from your home. Even though the interest rate is low, such behaviour could put you years behind in paying off your house and building an investment portfolio. Budget your money!

8. Consolidate:  Pool all of your debts into one. The benefits here are that the overall interest cost may be lower than the interest cost you may be paying on some individual debts. This would certainly be the case if you used a line of credit facility. If the facility was attached to your mortgage, however, you may be eating into the equity on your home, which is an unwise strategy. See previous.

9. Be wary of “interest-free” offers: These are broadly offered on electrical goods and furniture but can be a trap because the interest rates you may be required to pay at the end of the interest-free period are usually extremely high. Before buying into such an offer, make sure you have adequate cash flows to enable you to make high regular repayments with a view to paying off the loan before the end of the interest-free period.

10. Be wary of short-term lending facilities: Money exchange services are an example, and they can be very costly. A new generation of credit providers in Australia, known as “pay day lenders”' operate national distribution networks and specialise in short-term, high-cost loans to consumers experiencing a cash crisis. Such facilities should never be used.

As “rules of thumb;” Never buy anything on credit. Spend less than you earn. Make a budget item for the amount you will save. Put your savings somewhere where it is harder to get out.
Stick to your goals more often than you do not.

For help, call Hugh Kilpatrick* of RIadvice Group on 03 9471 0080

*Hugh Kilpatrick is an Authorised Representative of RI Advice Group Pty Limited (ABN 23 001 774 125), Australian Financial Services Licence 238429. This editorial does not consider your personal circumstances and is general advice only. You should not act on any recommendation without considering your personal needs, circumstances and objectives. We recommend you obtain professional financial advice specific to your circumstances.