Debt Management

Staying in Control

While most of us prefer to concentrate on what we own, rather than what we owe, debt has become a perfectly normal and acceptable part of the modern world in which we live. It is considered a “necessary evil”. Without debt, it is unlikely that most of us would ever be able to purchase our own home (using a mortgage) or our car (using a personal loan).

In today's competitive financial services environment, there is a myriad of lending (debt) products on offer - with terms, conditions, options and interest charges to suit every need.

Comparing these products, and selecting the one that best matches our needs at the time, is a time-consuming and often perplexing task. But, choosing the most convenient rather than the most appropriate lending product, could have a substantial negative impact on your financial well being.

 

What is Debt Consolidation?

Put simply, debt consolidation is the process of replacing several separate loans (or debts), with one new loan (or debt). For example, you may have an existing home loan, a car loan and also some credit card debt. A new loan (secured against your home) is taken out which effectively pays out these three debts and then continues to operate as a normal home loan.

But, is debt consolidation the right answer for you? The ability to combine a number of debts into one “neat package”, is attractive. However, before proceeding, you should seek expert advice from your financial planner to ensure that this really is the best option for you. There are several interesting consequences of using a single new (and larger) loan to replace a portfolio of existing personal debt, which can be both potentially advantageous or disadvantageous to you, depending on your individual circumstances:

The potential advantages of debt consolidation include:

• the annual interest paid on the new loan is usually less than the total annual interest paid on types of debt you may have. For example, credit card and personal loan interest rates are normally higher than those on housing loans;
• annual repayments on the new loan will often be considerably less than the total repayments made on all your current debts;
• the ongoing transaction costs associated with the one consolidated loan may be significantly less than the total costs currently incurred on the five existing facilities; and
• ease of management - just one monthly statement and one monthly payment.

The potential disadvantages of debt consolidation include:

• a loan which might otherwise be repaid over a shorter term (for example, personal loans are normally repaid over a one to five year period), will now be all repaid over the longer term of the new loan;
• the longer term of the new loan means total repayments made will be considerably greater than the sum of the total repayments of current multiple debts (unless some early repayments of principal are made); and
• there may be costs associated with the taking out of the new loan and the early repayment of the other facilities.

Why Consider Debt Management?

Debt is simply something owed by one person (the debtor) to another. However, it is most commonly associated with the obligation we accept to repay the lender both the original sum we borrowed (called the “principle”) and also any interest or other charges set out in the loan agreement.

It is incredibly easy to acquire debt - indeed, the banks (and other non-bank lenders) seem to be “falling over themselves” to lend us money.

 

Selecting Your Lending Product

Like most people you may not have the time or the expertise to ensure you get the debt that is best suited to your needs. It is much more convenient and less confusing to simply accept the first option offered to you - one which is often linked to the purchase itself. Thus, you may be repaying a series of debts, all of which have different terms, conditions, fees and interest charges and repayment dates.

The table below captures the most common forms of debt and lending products:

Purchase	Type of Debt	Interest rate*	Term
Own home	Mortgage	6%	Normally 20-30
Car	Personal loan	9%+	Normally 1-5 years
Smaller household purchases	Credit card/Store cards	12-30%	Ongoing, but normally requiring a minimum payment of 5% of credit balance
Telstra, CBA or other share purchases	Personal or margin loan	9%	Dependent on terms and conditions of actual loan. Can be set repayment of principal and interest, over set term, or interest repayment only

* Interest rates are used for illustrative purposes only and may not be correct.

Interest rates, terms and conditions, and fees charged vary markedly between lending organisations. What began as the easiest option at the time, can quickly become a very confusing maze of multiple monthly repayments, due on different days, to different institutions.

It can also become very expensive, as each one of these debts will usually have an associated series of start-up costs and ongoing account-keeping or maintenance fees and charges. Government fees in the form of stamp duty, are often levied as well on each new borrowing. Interest is not the only cost we pay on debt products.

When you purchase an asset, you normally do so with the purpose of accumulating wealth either through appreciation (growth) or income (dividends etc). Yet, while trying to make your hard-earned dollars work that little bit harder for you, you may face often unnecessary fees, charges and higher interest on debt products that don't really suit your individual needs.

 

The Importance of Regular Reviews

Debt management is a process whereby you actively manage and review what you owe, to ensure that you are not paying any more than you need to, when purchasing assets. While reviewing your portfolios is considered to be an essential part of the asset accumulation process, so too should be the regular evaluation of your debts and liabilities.

In essence, it is essential to not only carefully select the lending solution at the outset, but to also regularly review whether the long-term lending product you committed to, is still the right choice for you.