Deal with debt A resource to help you get control over your debt. Remember you could be using the money you spend on interest on something else! Information given is of a general nature only and does not constitute personalised financial advice. While BNZ has made every effort to ensure that the information provided is accurate, individuals should not rely on this information to make any financial decision without first having sought advice from their financial adviser, or make an investment without first having read the relevant investment statement. Kia ora, Welcome, Talofa. Getting control over your debt gives you peace of mind. This resource will help you: tell good debt from bad debt see how your interest and your debts affect each other consider other options instead of borrowing know more about how to reduce your debt plan how to deal with family lending. Debt quiz No Yes Do you use debt to fund your daily living expenses? Are you unable to make debt payment on time? Do you use one credit facility to pay the minimum requirement for another? Are your credit cards and overdrafts near their maximum limits? Do you buy things on credit when you know you can t afford to pay cash? Are your debts growing although you spend all your income on paying off debt? Do you throw out letters from lenders before opening them? Has your credit card been declined because you have exceeded the limit? If you answered yes to any of the questions above you may need to go on a debt diet. 1
Meet the Wilsons We ll use the Wilsons as an example of some of the situations we re going to learn about in this resource. The Wilsons have different levels of debt, and different approaches to dealing with it. Ruby & Johnny 25 & 29 years I hate that I m in debt, I m not happy till it s all paid off. Ruby and her partner Johnny earn $62,000 a year before tax. They have a one-year-old baby, Marama, and Johnny also pays child support for his eight-year-old son, Ben, from a previous relationship. They have $5,000 in credit card debt and are paying off the loan for Ruby s car. They re saving to buy a house. Matt 27 years Annie 54 years Debt and cash, it s just the same to me. I know I make enough money to make the repayments, so I don t really care how much I owe. l love credit cards. Matt is Johnny s brother. He earns $48,000 a year, but he s having a bit of trouble keeping up with his payments. Between the credit cards and the personal loans, things are getting tricky. Annie, Ruby s mum, has a good job, earning $65,000 a year. She has a house with a mortgage, a couple of personal loans, a number of credit cards, and an overdraft. She has an investment account, and she s looking to start really working on setting up a comfortable retirement that way. What s your debt style? Ruby Ruby has a tight budget and credit card debt, and she is paying off her car loan. She had to think long and hard before taking out each loan. Ruby usually saves up for big-ticket items. Ruby has a low tolerance to debt. Annie Annie has a good job and credit is easy to come by. She has a mortgage, personal loans, a number of credit cards, and an overdraft. She is comfortable borrowing large amounts of money. Annie has a high tolerance to debt. Are you more like Ruby or more like Annie? Tick your level of debt tolerance. low medium Level of tolerance to debt high What about the rest of your family? low medium Level of tolerance to debt high 2
Good debt and bad debt Good debt Future investments Items that don t lose value Emergencies Low interest rates, longer term debt Mortgage for a house, student loan for education, business loan Bad debt Immediate use (dining out or travel) Items that lose value quickly Unaffordable lifestyle High interest rates, short term debt Credit cards, car finance, hire purchase, store cards Are these debts good or bad? Check you understand by seeing whether these debts are good or bad. Good Bad Johnny and Ruby owe $5,000 on a joint credit card. Johnny and Ruby plan to borrow $225,000 to buy a house. Matt buys a new TV on hire-purchase with no payments for six months. Mike is thinking of taking out a $12,000 student loan over three years, so he can afford university. Johnny and Ruby bought a used Holden sedan to be their second car, with a $15,000 car loan. Matt spends $2,000 on his credit card on a laptop. Think about your own debts. Are they good or bad? Good Bad 3
The cost of debt What makes interest rates high or low? High interest rates because: No security No guarantor Bad credit history Short term Credit card Putting off payments (for example, six months before the first payment ) Personal loans Low interest rates because: Assets for security Another person to guarantee Good credit history Long term Mortgages Asset-backed loans (for example, guaranteeing a loan using your car or home) Tip! A credit check tells a lender about whether we will pay our loans back. It is based on our borrowing and repayment defaults in the past five years. What interest rates are you paying on your loans, credit cards, and hire purchases? High (over 10%) Low (under 10%) 4
Higher interest rates and longer repayment times mean debt costs more. Let s have a look at how interest rates and repayment times affect debts. Matt s laptop Matt bought a laptop for $2,000 on his credit card at 19.5% interest a few months back. He started paying the minimum payment but didn t realise that the minimum payment doesn t actually pay back the laptop. Most of the payment is interest and his payments reduced only a tiny fraction of the loan amount. Let s see what happens if he pays some more each month. Monthly repayments How many months to pay off? Total interest paid How much for the laptop? $34 (minimum) 176 $3,955 $5,955 $50 64 $1,166 $3,166 $100 24 $391 $2,391 What else could Matt have done? Saved up for the laptop Bought a cheap second-hand laptop Used the library computer until he could afford one Mike s repairs Mike s car needed $250 of urgent repairs, so he borrowed the money from a personal loan shop. He paid the money back in two weeks, as agreed, and paid another $50 in interest. Was it worth it? Mike paid $50 for $250 over two weeks. That s 20% interest in just a fortnight! What if he d borrowed for a whole year? That would be 521% interest! What else could Mike have done? Sold something he doesn t need Asked his employer for an advance on his salary Borrowed from family or friends Ruby and Johnny s car Ruby and Johnny decided they needed a second car to make things easier with the baby, so they bought it on hire purchase, with a deferred payment. They signed a four-year finance agreement for $15,000 with the payments for the first six months deferred. How much more did it cost because they deferred the loan? $15,000, 48 months to pay, $110 per week, 6 months deferred. Total interest paid: $4,942 over 4 years. If they hadn t deferred the payments, they d have had to pay only $93 per week, and the total interest would have been $4,255. What else could Ruby and Johnny have done? Borrowed an amount they could start payments on at once Paid back as soon as they can rather than as late as possible $4,942 $4,255 = $687 that they could have saved! 5
Let s look at your debt Before you buy on credit think about: Do I need it? Do I need it now? What s the true cost? Can I afford it? Are there alternatives? Do you know how much you and your family owe? Hire purchases Mortgages Personal loans Credit cards Bank loans Student loans Overdrafts Loans from friends or family Write down all your family debts. (You may need to finish this at another time, after you have done some research. You can get a rough estimate of the total interest you re looking using this sum: Months to pay 12 x Interest rate 100 x Total debt owing x 0.6.) Debts How long to pay it off? Interest rate (%) Monthly payments ($) Total debt owing ($) Interest estimate Total Matt s debts Debts How long to pay it off? Interest rate (%) Monthly payments ($) Total debt owing ($) Interest estimate Credit card 1 7 months 19.95% $350.00 $2,000 $140 Credit card 2 14 months 19.95% $400.00 $6,000 $840 Car loan 12 months 16% $907 $10,000 $960 Personal loan 12 months 12.95% $446 $5,000 $390 Total $2,103 $23,000 $2,330 Remember that to multiply using a percentage, you divide the percentage by 100. e.g. 2 x 10% would be 2 x 0.1. 6
Steps to get control Stop paying for things with credit Buy only things you can afford. Put off spending on high cost items. Matt cuts back all his spending He is making his own lunch and has stopped going out with his friends to cafés. He decided he didn t need a new ipod after all. Start paying off your debts Option 1: Pay the highest interest-bearing debt first. Option 2: Pay the smallest balance first. Matt decided to pay the smallest balance first With his lifestyle savings, he paid off Credit Card 1. The Credit Card 1 payment was put towards paying off Credit Card 2. Think about a consolidation loan A consolidation loan rolls all outstanding debts into one loan with one interest rate. It means one interest charge and only one payment to make. Ideally you should try for a lower interest rate for your consolidation loan Matt got a consolidation loan from a bank His new loan is $21,000 at 11% interest for 18 months. One payment of $1,500 a month and interest savings of $591. Stick to your plan Motivate yourself by thinking about a debtfree future. Think about having the money to achieve a significant life goal. Matts feels much more in control now He is on track to be debt free in a year. He is looking at a trip to Australia at the end of next year. Don t make a lifelong commitment to debt. This is one relationship you can afford to end sooner the better! 7
Plan how you ll cut down your debt Cutting your spending Start paying off your debts Which debts can you pay first? What can you achieve if you stick to your plan? 8
Lending to your family and friends Sometimes our friends and family need a little help to get by. Can we afford to help them? Saying yes can be worse for the relationship than no. Lending money changes the relationship to lender and borrower. This can create a strain in the relationship until the money is paid back or even after. Let s make some rules about lending money to friends and family. Which of these rules would you use? Maybe you have a few that work well with your loved ones. Think about good rules and use the spaces below to write in yours. One loan at a time. Only have one outstanding loan at a time. Lending multiple amounts to the same person or a number of people makes it a headache to keep track. Only give cash. If you co-sign a loan, if the money isn t paid back, your credit history gets affected. You might get a bad credit rating without even knowing about it. Write it down. If you make a simple contract, it will help clear up any misunderstandings and save you an argument later. Can you afford it? Lending money reduces your cash flow right now. It s a good idea to think about how much you can afford to lose if you don t get the money back. There might be other options. Maybe you can help fix the car rather than lend money for a mechanic. Our rule 1: Our rule 2: Note: There are more resources in this series to help you be good with money... 9