The average Australian household holds $183,900 of debt, the second highest household debt-level in the world. As we continue to face the economic impacts of COVID-19 and experience our first recession since 1991, it’s important that we are all thinking about how to manage debt.
High levels of debt are linked to not only financial issues, but mental and physical health and relationship issues too. It may mean that we work longer and can take away our ability to spend money and time on the people and things that are important to us. So, if you’re struggling with debt, the impact can be far-reaching.
Here are our top tips for managing household debt.
#1 Recognise good vs. bad debt
When we talk about debt, it’s often in a negative sense, but it’s important to recognise that there is good and bad debt. Good debt is debt that is designed to get you ahead and help you reach a financial goal sooner, such as investment loans. (Of course, if they’re not manageable, ‘good’ debts can become a problem too.)
Bad debt is essentially borrowing to purchase a depreciating asset; think cars, consumer goods – clothing, electrical, furniture – essentially any purchase that won’t increase in value or generate future income. Whether or not the debt is manageable, going into debt for these purchases is rarely a good idea.
#2 Understand what bad debt is actually costing
High interest debts, like credit cards, are costing Australians billions each year, with a system that often encourages people to stay in debt. Minimum repayments are there to make you feel as though you are managing your debt, but if you are only making these, it’s hard to get on top of the debt and will cost you considerably more.
For example, if you have the average Australian credit card debt of $3,258 at an interest rate of 16.58%, it would take more than 22 years to pay off the balance by paying only minimum repayments, and would cost $8,798. Conversely, if you commit to paying off $158 per month, you’d lose the debt in just 2 years and pay $3,798.
Understanding the actual cost of your debt is a great first step in getting on top of it. You can use a calculator like this one to get a handle on how much you need to pay each month to make a dent in your balance.
#3 Prioritise your spending
For many people, setting a budget is often thought of as an exercise in restricting their lifestyle, but that mindset will most likely ensure you fail. A budget is simply about knowing where your money is going and giving yourself the freedom to use it in a way that aligns with your values and what you want out of life – rather than spending on things that don’t matter or trying to ‘keep up with the joneses’.
When budgeting, many people are surprised to find that they are spending considerable amounts on things that they don’t value and reducing their spending in these areas has little to no impact on their lifestyle.
Your spending habits should be a direct reflection of what you value – so if it’s not actually making you happy today or setting you up for future happiness – give it the flick. To get you started, you can download our free budget planner here.
#4 Commit to a payment plan
Once you have prioritised your spending, you’ll know how much you can commit to paying on your debt. There are two common methods to pay down debt, known as the avalanche and snowball methods.
The avalanche method is where you pay down debt from highest interest rate to lowest, and it’s often a good method to reduce the overall cost as you minimise the interest you pay.
The snowball method is about paying debts from smallest to largest in amount, regardless of the interest rate. This method can be good if you have many small debts to avoid multiple fees, and keep you motivated as you can feel a greater sense of achievement as you free yourself from each debt.
Both methods can work effectively, it’s just about finding the method that works best for you and the one you’re more likely to stick to.
#5 Think about money differently
Freeing yourself from debt is a big step and when you have done it, you will feel a greater sense of financial freedom than ever before. But it’s important that you address the reasons you got into debt in the first place to avoid it happening again.
While life circumstances and unexpected events can, of course, play a role in accruing bad debt, it often also comes down to our attitudes towards money. Financial literacy, or how much you know about money, is one of the biggest determinants of financial success – in everything from everyday savings to retirement, so it can be a great place to start.
There is a wealth of free resources out there to help you better understand finances, including our Knowledge Centre, which offers articles, calculators and even education modules to help you navigate your finances. For those who need a little extra motivation, we also offer a free email bootcamp, designed to help you take practical steps to improve your financial health.
Contact Apt Wealth Partners to find out how we can act as your personal finance coach, an expert in your corner to help you live for today while planning for tomorrow.
General Advice warning
The information provided in this blog does not constitute ﬁnancial product advice. The information is of a general nature only and does not take into account your individual objectives, ﬁnancial situation or needs. It should not be used, relied upon, or treated as a substitute for speciﬁc professional advice. Apt Wealth Partners (AFSL and ACL 436121 ABN 49 159 583 847) and Apt Wealth Home Loans (powered by Smartline ACL 385325) recommends that you obtain professional advice before making any decision in relation to your particular requirements or circumstances.