DEBT MANAGEMENT

  1. Home loan debt and how to manage it

  2. Other personal debt and how to manage it

  3. Consumer debt and how to manage it

  4. Investment debt and how to manage it

  5. Special purpose debt: reverse mortgages

  6. Some general thoughts about borrowing

Contents

Introduction

Most people have debt. And if they don’t, they should consider having debt.

That might sound like a reckless statement, but as you will see in this ebook, used well debt is an extremely useful tool.

Of course, used badly, debt can be dangerous. So you have to get it right. The old saying is true: all things in moderation. Especially with debt.

This ebook is all about using debt well. It is an important book, because the way in which people manage their debt performs a vital role in the success or otherwise of their financial management.

For example, think about the simple home loan mortgage that virtually every person takes out to buy their own home. According to the Reserve Bank of Australia, 36% of Australian households hold some form of home loan (as of 2012). Households led by people aged between 35 and 44 (54%) and 45 and 54 (50%) are the households most likely to have home loan debt. The median value of these home loans was $200,000 in 2012 (it would be higher now). As of December 2015, the indicator interest rate for owner-occupied home loans was 5.65%, suggesting a median interest payment of at least $11,300 per year.

At the same time, average disposable (ie after tax) household income in Australia was around $50,000 a year. Putting these two figures together suggests that interest payments on home loans accounts for (on average) something more than 20% of household’s disposable income.

You can see, then, that managing this interest expense as well as possible opens the door for increased wealth and financial security.

And that is just for home loans, which are usually filed in the ‘good debt’ file. What about debt that we usually describe as ‘bad?’ According to ASIC, the average level of credit card debt per credit card holder is $4,371. This constitutes around 5.5% of total household debt. And according to the Reserve Bank of Australia, 28% of households have some credit card debt. The presence of credit card debt is reasonably consistent for all ages and income types, with a dip in the incidence of credit card debt for unemployed people.

As of December 2015, the indicative interest rate for credit cards was 19.75% (Source: RBA). This suggest an average interest bill for card holders up around $1,000 per year.

You can see why we normally refer to credit card debt as “bad.”

Now, what about investment debt, which, history suggests, is likely to make the borrower better off? This means it is usually ‘good debt.’ Well, according again to the Reserve Bank of Australia, only 10% of households have any form of investment property debt. 90% of households don’t. Interestingly, the rate for University graduates is 16%, while the rate for early school leavers is 5%. A university graduate is three times more likely to borrow to invest than someone who left school early. The median investment property loan was $242,000 as of December 2012, which is a little more than the average home loan, and the indicative interest rate for investment property debt is 5.90% as of December 2015. This suggests an annual interest bill of around $14,500. That bill, however, needs to be offset against any extra income being generated by holding the asset (think rent for property investments and dividends for share investments).

Finally, what about personal loans, which might be good or might be bad, depending on how the money is used? For example, borrowing $10,000 for a life-saving medical procedure is good debt. Borrowing the same amount of money for an upgraded home entertainment suite isn’t. Well, according to the Reserve Bank of Australia, 37% of households have some form of debt other than home loan, credit card, HECS or investment property debt. The RBA reports a median value of $11,000 for such debt, with an indicative interest rate of 14.10% for such debts. This suggests around $1,500 of interest on personal loans each year. As we say, this interest bill might be money well-spent: it all depends on how the loan is used.

So, you can see that debt is pervasive. Read on to find out how best to manage this common element of your financial planning.

Types of debt: the good, the bad and the ugly

 

Debt is a fact of life for most people. It may come from starting a business, buying into a business, buying a home or acquiring investments. It requires careful management and control so it does not cause financial loss and pain, which is the very opposite of wealth creation.

 

Unless you are born wealthy, there is normally no choice but to borrow to acquire assets of any significant value. It is hard to save up $600,000 or so to buy a home. By the time you do, you will probably be looking for a retirement home.

A controlled amount of debt, used intelligently, can have a wonderful, positive influence on the quality of your life and on your net wealth position. It allows you to acquire assets otherwise outside of your reach and to benefit as the value of the assets rises and as the debt is gradually repaid.

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