Neither a borrower nor a lender be!

21 May 2013

By Jeremy Taylor, Private Client Adviser

Wise words from William Shakespeare's Hamlet, but maybe we need to update it for the 21st century - "be not a borrower".

Debt is a part of life these days with most people having mortgages, car loans, credit cards but not all debt is useful.

If it's helping you accumulate an asset that is going to grow in value it can be useful (a car should certainly not be included here). If you've racked up $20,000 on your credit card for that Europe trip....the memories will be pricey, not priceless!

If you are only making the minimum payments on your $20,000 credit card debt (approximately $375 per month), it will take you 10 years and 9 months to pay off your debt. In addition to the $20,000 you owe, you'll also pay an additional $28,375 in interest.

Likewise with your mortgage. Based on a $500,000 mortgage over 30 years, your minimum repayments will be $2,394 per month. On top of the $500,000 principal, you'll pay $558,000 in interest.

Like me, I am sure you don't want to pay more interest than you really need to. What I find most of my clients struggle with is which debt to pay off first.

You should start with your highest interest-bearing debt and work down from there. The maths is overwhelmingly. Take your credit card as an example. Most credit card interest rates are around 15-20% per annum. For every $1 you repay off your credit card, you are getting a guaranteed after-tax return on your investment of 15-20%. That's right. Guaranteed, after-tax!

It's exactly the same for the rest of your personal debt – the interest you are being charged is the guaranteed after-tax return you will receive by paying it down.

For most people the order of paying down debt should be – credit cards, personal loans, car loans and then your mortgage.

Did I mention the guaranteed after-tax return? Compelling stuff!

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