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Getting on top of debt

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With interest rates at their highest level in 11 years and consumer spending at record levels, managing your debts can be a careful balancing act.

It’s easy to see how our ability to spend more keeps increasing. A mortgage lender may offer you a bigger than requested loan or a credit card company may increase your credit limit without checking if you have the capacity to repay higher levels of debt.

Keeping debt under control

There’s good debt and bad debt. Good debt is defined as borrowing to invest in an appreciating asset, such as shares or property. Bad debt is money borrowed for something without anything to show for it, such as holidays or a depreciating asset like a car.

If you find that you’re suddenly in a position with too much ‘bad’ debt, you need to look for ways to reduce the amount of interest you’re paying. You can try and consolidate your debts with the highest interest rates (such as credit cards) into one loan with a lower interest rate. This will help you save money on interest and also make it easier to track (and control) how much you owe. Plus, it should help you pay your debts off faster.

Taming the mortgage beast

If you’re keen to cut down the size of your mortgage, see if you can switch from monthly to fortnightly or weekly repayments. The extra repayments each year will make a big difference in the long run. The experts say that if you can afford to pay an extra $25 on your mortgage every month, then it’s better than paying in $300 once a year.

If you’re thinking about taking out a large mortgage, you may want to do a trial run before you arrange the loan. You can try saving an amount equal to your loan repayments or the difference between your rent and home loan repayments (including the one-off transaction costs like stamp duty, moving house and legal fees).

Note that you may be overstretching yourself if your total loan repayments represent more than half your take home pay.

Pros and cons of fixed interest rates

With the outlook for interest rates uncertain, you may be wondering which is the best home loan structure for your situation. Fixed rate loans can give you protection in a rising interest rate environment, but the risk is that if interest rates fall, you end up paying more on your interest bill. Although, there are some investors who prefer fixed rate loans because they need to have some certainty about the size of their loan repayments.

However, fixed loans won’t suit every borrower because they don’t offer the same level of flexibility as variable loans. There are often restrictions on extra repayments which can stop you from paying off the loan faster. Some fixed rate packages don’t offer unlimited redraw facilities, or offset accounts, which allow borrowers to use their savings to reduce the size of their loan.

If you’re trying to pick whether a fixed or a variable rate is right for you, it’s possible to hedge your bets with a part variable, part fixed loan. Be aware that there may be switching costs and exit penalties involved. Some variable loans have exit penalties if you break the loan contract within the first 5 years – or if you’re on a fixed loan, you leave before the fixed period has expired. Lastly, make sure that you shop around, as your current lender may not have the cheapest deals.

If you need help getting on top of your debt, contact your adviser to work out the best strategy for you.

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