debt
Managing debt
It’s easy to get into, harder to get out.
Inside . . .
Think before you go into debt Know your borrowing options Pay off debt or save? Get out of debt fast
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debt
Think before you go into debt
It’s good to be able to borrow money. It can help you build up assets – like a house, a business or an education. But debt can also be a trap. The interest you pay on debt sucks your money away from you and stops you building your wealth or ‘net worth’. Your net worth is what you own, less what you owe. Going into debt is a big decision. When you have debt, your life options can start to become far more limited. Debt comes in many forms – credit cards, hire purchase, mortgages, personal loans. There’s no shortage of people out there wanting to lend you money.
Do you need to borrow?
At Sorted, we have three simple rules about borrowing and saving:
1 Ask yourself ‘do I really need the
Borrow to invest in an asset you need Some assets are good. Once you’ve paid for them, you have something of value that you could sell if you had to.
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There are two main types of assets: Value builders are assets that are likely to hold their value, grow in value or give you income after you’ve paid for them. Value builders include houses (although they can lose value) and education, which improves your job prospects and ability to earn income. Value losers are assets that lose value after you’ve paid for them, like a car. Borrowing to buy a car can be a bad move – especially if it loses value faster than you can pay the debt off. If you really need to buy a car (or any other value loser), think about saving for it, or borrowing only part of the purchase price.
3 Save to pay for expenses or non-essentials
item or service I want to buy – and can I afford it?’ Deciding whether you can afford to borrow money involves more than just deciding if you can meet the loan repayments. For example, you may be able to afford to borrow money to buy a car, but have you worked out what it will cost to register, run and maintain? You need to work out the full effect of the purchase on your budget before deciding if it’s worth borrowing for.
Don’t be sucked in by easy credit Make an informed decision – don’t let easy credit lead you to spend more than if you were spending from your savings. If you had to take the money out of your savings account to pay for this, would you?
Use the Regular Savings calculator to work out how quickly you could save the money so you don’t have to borrow it.
Remember – getting into debt is easy. Getting out of it is much harder.
It can be painless to pay for a meal in a restaurant on your credit card. But if you take a few months to pay off the card, it can be very painful when you realise that interest is making that meal more expensive every day.
Know the full cost of getting into debt Borrowing money has a price – know the full costs before you get into debt.
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Get your debt
debt
Pay off debt or save?
As a rule, it makes sense to try to pay back your loans as fast as possible before you start saving – particularly if you have high interest debt like hire purchase or credit cards. However, there are some cases when it’s good to do both – pay off debt fast and save at the same time.
Get into the savings habit Some people feel more comfortable starting a small savings scheme while they are still paying off a loan (such as a mortgage).
You’ll get into the habit of saving, and start to build a small nest egg. You’ll also start to build your knowledge of savings and investment options, so that you’re better prepared when you want to start serious saving.
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Combine your debts to save money
Credit cards have higher interest than mortgages – perhaps more than twice as much! Think about ‘consolidating’ your debts onto a lower interest mortgage.
Know your borrowing options If you decide you need to borrow, make sure it costs you as little as possible.
Once you’ve decided on your best borrowing option, work out how much you can afford to borrow, and how quickly you can pay it back. You need to take into account:
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Joining KiwiSaver Even if you have debt, you may be better off financially joining the government’s KiwiSaver retirement savings scheme because of the incentives offered. Workplace saving Some employers offer their own subsidised retirement savings schemes. This means that for every amount you save, your employer also contributes some money. You may be better off paying into a scheme like this, as well as repaying your mortgage or other loan faster. KiwiSaver also has employer contributions. Saving for an emergency fund It’s common sense to have an amount of money (say two or three months’ income) you can call on if the unexpected happens. It means you won’t have to borrow money or be left financially vulnerable. Saving for an emergency fund may not be such a good option if you’ve got high interest debt.
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Try these online calculators
Thinking of saving rather than borrowing? To find out just how fast you could save the money you need, try out the Goal Machine calculator. Just enter how much you want to save and by when, and it does the calculations for you. Understand the real cost of a loan before you take it on. Use the Get into Debt calculator to calculate the total interest you’ll pay by the time you pay off a loan.
How much you want to borrow. The interest rate you’re likely to pay. How long you’ll be borrowing for. How often you’ll make repayments.
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Use the Get out of Debt calculator to see the impact a small increase in repayments can have.
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Find out about your rights as a borrower, the different ways to borrow and how much each option costs.
www.consumer.org.nz
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Get your debt
debt
Get out of debt fast
The longer you have debt that charges interest, the more you pay. So it’s a good idea to:
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Kiwi story
Compound interest applies to borrowing too Just as you get compound interest on savings, you pay compound interest on the money you borrow.
You can’t do without your sleep…
Trudy is 28, single, and working in an office. She’s earning a good salary, and she loves buying beautiful things. Over the past couple of years she has built up quite a bit of debt, and she’s got absolutely no savings. Her credit card balance is $3,000 and she owes $1,200 on HP. It’s high interest debt so she’s been making a concerted effort to pay it off. But with no savings Trudy is concerned about not having anything put aside for emergencies (like her car breaking down!). In fact she is worrying so much about her money situation that she isn’t sleeping at night. Trudy visits www.sorted.org.nz and realises that her biggest concern should be improving her net worth – the difference between what she owns and what she owes. So she decides to take a long-term view and stay focused on getting rid of her debt. She sets a goal to pay off her credit card and HP balance in six months. After that, she will start saving for the emergency fund.
Get rid of your high-interest debt first (such as credit cards and hire purchase). See if you can increase your loan repayments to clear your other debt faster – but check with your lender that this won’t result in penalty payments.
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Then get saving!
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Get out of Debt calculator
The Get out of Debt calculator will help you to work out how to get rid of your debt faster. Just enter the relevant figures and you’ll see how long it will take you to pay off each of your existing debts, and the interest you’ll pay. You’ll also see what happens if you increase your repayments.
Paying off your mortgage as fast as you can is a great financial decision.
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Get your debt
Where to now?
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Borrowing only what you need? Know the true cost of your debt? Paying off your debt fast (high interest first)?
Next step:
e.g. use Sorted’s Get out of Debt calculator.