My spine tingles and my toes curl up just hearing the word…debt. I want to get as far away from debt as I possibly can. As I shrug off my irrational fear of debt, I pause and think to myself, “why am I so afraid of debt?"
The answer is simple. The fear of debt starts off as an emotional impulse; a small AfterPay payment that you've been meaning to pay off or that trip overseas that you put on credit in order to get that holiday special. As I rationalise the purchase I can't afford, Steve, the scary debt monster slowly creeps in and fills my mind with guilt, making it harder for me to take control before it's too late.
As I search far and wide for answers as to how to defeat Steve, Clint Benn from Benn Financial Planning understands why people have the scary debt monster lurking around and he sums it up in one simple sentence – People don't want to psychologically address their debt and be realistic about their financial situation, thus perpetuating the debt cycle while their interest repayments continue to compound.
If you have a scary debt monster Steve, who has decided to move in, access your process wifi and eat your snacks, have no fear. Things are going to be ok if you take these four simple steps suggested by Clint.
1. Make a list of all the debt you currently have from the smallest to the largest.
It's critical to get a bird's eye view of your current debt situation. This includes making a list of all your current debt loans from smallest to largest, including listing their interest repayments and loan term. By understanding your total debt structure, Clint explains, “you and your financial planner will be able to accurately discuss, evaluate and implement an achievable debt reduction strategy".
2. Try the snowball method
This method works in conjunction with Step 1. Once you have made a list of all your debts from the smallest to the largest, begin to pay off the smallest debt you have. As you repay each debt, you begin to pick up momentum (like a snowball rolling down a mountain side) and before you know it, you have cleared yourself from all debts.
This strategy is not only a psychologically rewarding method, but also provides you with security in case of emergencies. Clint explains, “in the event of an unexpected financial hardship, if you have paid off the smaller debts first, this creates some sense of financial security as you have a smaller number of debt types to repay. It's always easier to pay off the smaller amounts first rather than barely making a dent in a large loan and be stuck with the same number of loans in a financial crisis".
3. Consolidate to save on interest but continue to pay the debt off in the same amount of time.
This is a classic example of debt perpetuation. Consider this, you have taken out a personal loan at 12% for three years and have a mortgage at 4% over 30 years. You take the appropriate step of consolidating your personal loan with your mortgage to lower your interest repayments.
But here comes the “ah ha" moment. While the first step of consolidation is correct, most people continue to pay off their personal loan at the 4% interest rate, over 30 years, instead of the original loan term of 3 years. This results in you paying more for your personal loan than needed.
Clint suggest consolidating the smaller loans into your mortgage under a master limit so that you can pay 4% on your personal loan over the 3 years as you work to pay it off in the original loan term. If you extend the smaller loan payment over the same terms as a mortgage (over 30 years), you end up paying more.
4. Speak to a professional about converting non-deductible debt into deductible debt.
You've heard the saying, “Making your money work for you". Did you know that the same could be said about debt?
Clint explains, “the best way to make your debt work for you is to turn your non-deductible debt into deductible debt".
Some debt is classified as bad debt. These refer to credit cards, personal loans, lay-bys and personal vehicle loans. These are bad debt because you cannot claim on them to minimise your tax earnings for the year. The other type of debt is good debt aka deductible debt. These refer to mortgages, business loans and educational loans. By restructuring your debt portfolio to make a portion/all of the loan deductible, you will be able to save on tax.
The scary debt monster is nothing more than our own natural instinct to avoid things that are negative or foreign to us. By seeking the help of a financial planner such as Clint Benn, who specialises in debt management strategies, you will be able to kick Steve the scary debt monster to the curb once and for all.
Disclaimer: Information in this article is general information only and hasn't taken your circumstances into account. Please seek the professional guidance of a financial planner, mortgage broker or debt management specialist to receive accurate financial advice for your personal circumstances.