Debt Management - Some key points to consider
Most people in Australia have some form of debt irrespective whether they are working or not. Debt is one of the greatest threats to an individual’s well-being and a Nationals economic position. Debts are carried by students, pensioner, workers, superannuation funds, family trusts and companies.
There are two kinds of debt, good debt and bad debt. Good debt is a loan that allows the borrower to claim a tax deduction on the interest paid on the loan. Bad debt is a debt where the lender cannot claim the interest costs as a tax deduction and therefore reduce their overall income tax liability. Whether you have good or bad debt, there is always a degree of risk involved. If circumstances change, or if you have borrowed beyond your means, then it could be difficult to sustain any debts over the long term. This can lead to default and more serious issues such as bankruptcy.
There are many types of debts Australians may be carrying that needs addressing. The following debt products are in order of loan size and priority for most individuals. Most of debt relates to building wealth through home and investment loans.
- Mortgages/ SMSF/ Home & investment Loans
- Investor / Margin/ Investment Loans
- Personal/ Small loans/ Overdrafts
- Student/ HECS/ VET Loans
- Credit Cards/ Store cards/ lease
Since the Global Financial Crisis, Australians have continued to increase their personal debt levels with purchases of investment property and personal credit card debts. The following are current risk factors that may quickly lead to having unmanageable debt.
- Loss of employment and job insecurity
- Loss of life, illness or disability. Not having adequate personal insurance
- The current low level of interest rates on mortgages. They may start to rise quickly in the future.
Many factors have driven house prices to unprecedented levels creating the issue of low housing affordability for younger generations wanting to move into the property market. The Reserve Bank of Australia current wholesale market cash rate is at the lowest (1.5% p.a) it has been for over 60 years. Although the government has not been able to slow down the growth in debt levels it has introduced several housing affordability measures to assist younger Australians enter the housing market. They include the following measures.
- First Home Savers scheme
- Downsizing superannuation contributions
- Strict rules for foreign investors owning Australian housing
- A further Capital Gains discount (60%) for investors offering affordable housing.
- Extending first home stamp duty exemption
Financial Planning should consider the management of debt as priority when developing a client’s financial plan. As a starting point if you have debts, this should be your priority. Here are four strategies to keep in mind.
- Debt Consolidation: This involves reducing the number of bad debts into only one facility with the lowest interest rate possible. This will save you thousands of dollars over the term of your loan
- Create a Budget: Understanding your level of income and expenses allows you to free up unnecessary expenses to increase cashflow to pay off debt levels.
- Regular Savings Plan. Will allow you to create an emergency fund to pay for unexpected expenses rather than borrow the funds using high interest credit cards. I will also provide you a discipline to save and invest additional savings.
- Understand the kind of Debt you hold: Holding Principal home and investment loans at variable and fixed interest can add to your overall interest costs. The frequency of repayments and term of the loan can also impact on the overall interest cost over the long-term. Having debt secured or unsecured will also have a bearing on your overall financial position.