Three mistakes we make with debt
By Shadforth Financial Group
In my previous article 'Time poor and too busy to save' we looked at the key challenges facing young people when it comes to shaping their financial future. In this article I take a deeper look at one of today's major issues - debt.
I have often spoken to friends and colleagues who are in their 20s and, to some extent, most of us tend to have the same action 'plan' - complete University, build a career, buy our first home, get married, have kids.
It may not all happen in this order, but generally most of us are aiming to tick off a few of these things before we hit 30 years of age. Along the way we're going to stumble, but how can we be prepared so that we don't keep making the same mistakes?
I've listed three common mistakes that I see from people in the 20-35 year age bracket.
Mistake #1 – Over Extending Ourselves:
What I see a lot of today in Generation Y (myself included) is that we enjoy the finer things in life. We don't settle for the cheap or the 'used', we always want to find a way to take that big European holiday or to buy that new car. What we end up doing is over-committing and causing ourselves financial grief in the longer term for example:
The average mortgage in 2014 has increased to approximately $443,000.
Average credit card debt sits at $4,200 per card-holder.
So what are we actually doing wrong?
Our credit card limits are far too high. If you can't afford the interest repayment on $15,000 then why do you have that limit?
We get caught up in being a home-owner.
We want things now and we're not willing to wait and save.
Unfortunately the truth of the matter is that today's 20-35 year olds are not generally a generation willing to wait for things. Renting has become an inglorious way for most of us to live for example having to deal with rent inspections, rent increases, living with flatmates, etc. What your property developer doesn't tell you or you fail to ask when you're signing up for their brand new 4x2 home with a home theatre are:
- What the land rates on your new home are?
- Can you afford to insure the property and contents?
- How much does it cost if the hot water system blows up?
- What are the repayments if the interest rates increase?
Mistake # 2 – Not understanding your credit terms
It is very important to take time and actually read the detail aka the product disclosure statement that you receive when you take out a loan or credit/store card. Even better, you should research your finance options prior to actually buying anything and make well informed decisions. Some of the key points to be aware of are:
Interest Rates: Lenders will try and make credit terms look attractive, but the lowest rate isn't always the 'best'; you need to look into all the other fees they may also be charging you.
Term: Making a longer term on your loan will help with repayments and cash-flow but you'll pay thousands of dollars extra in interest.
Exit fees: Look into how this fee is charged, especially if you want to pay out the loan earlier than its set term (especially important on secured car loans).
Loyalty Programs: Points are great, but they can cost you. Is there an annual fee involved? Look carefully at how points are credited to your account, generally there are set hurdles you need to meet ie, spend so much and be with the provider for a certain period of time.
Interest free periods: The big one out now is interest free periods. Check what the rate reverts to after this period - will you be stung on interest charges?
Mistake # 3 – Not consolidating debt
Consolidating your debt can be one of the easiest ways to:
- Pay off your debt/s sooner.
- Reduce the amount of interest that you'll pay.
As a general rule, you should focus on the highest cost debt first and then work down from there. For most people this will be their credit and store cards.
Balance transfers are the easiest ways to consolidate your credit card debt and get an attractive interest free period to help get your debt under control. A few things you need to know about balance transfers:
- Not all offers are the same, so you need to do your own research
- What does the interest rate revert to after the initial interest free period?
- Is there an annual or balance transfer fee?
- What is the interest free period they offer and can you pay your debt off in this time?
- You will still need to meet credit and borrowing capacity rules set by the banking institution you use
Once you have paid off your credit card, start to move onto your other debts (personal loans, home loans, etc.) and continue to focus paying these down one at a time.
Although having a focus on reducing high cost debt will generally be the best option, it is important to check if a different strategy would suit you better.
Being aware of these mistakes is the first step; seeking good quality financial advice is the next step. Don't be intimidated about speaking to a professional before making these decisions. Look to speak to an expert who can focus on your needs and provide advice that is in your best interests.