Struggling with Debt? Here's How to Separate Your Debts

5 January 2016
What is an easy rule of thumb to work out if you have taken on too much debt?

Sadly, there’s no one-size-fits-all answer to the question of how much debt is too much. While some suggest that if 30% of your net income is being put towards home loan repayments signals housing stress, there’s not definitive measure for overall debt repayments versus income. That said, I think there are three broad questions you need to ask yourself about any amount of debt that you owe.

What type of debt do you have?

There are different types of debt: a home loan, for example, or a car loan, student loan, investment loan or a credit card. You need to ask yourself whether the debt that you have is for a good cause (such as buying a home or a good investment) or a not-so-good cause (such as a credit card debt).

Sometimes even relatively small amounts that we owe can still be too much. For example, owing $10,000 on a credit card at the average credit card interest rate of 17 percent is probably too much debt.

And here’s a quick calculation for you: based on the most recent statistics, we’re currently paying interest on more than $31 billion of credit card debt – and at an average credit card interest rate of 17 percent, that equates to around $5.3 billion of interest each year, or around $14.5 MILLION per day.

That’s $14.5 million that would be better off in our pockets each day! For our financial institutions that’s money for jam – and it’s a cost that most of us can easily avoid if we’re smart about what we do with our debt.

If there’s any good news about that, it’s that the amount of credit card debt that we pay interest on is currently lower than at any time in seven years… so just think how much money we’ve needlessly given to financial institutions over that time!

Just to labour the point, if you are one of the many that constantly juggles a credit card debt, it’s definitely worth shopping around for a credit card. At the time of writing, the lowest ongoing credit card interest rate on the Canstar database just 7.99% (Quay Credit Union) compared to the highest of 23.50% (GE Money).

What’s the opportunity cost of your debt?

Irrespective of the type of debt you have, is it the best use of your money? In other words, are your current loan repayments stopping you from doing something better with your money? The things that you can’t afford to do because of your loan repayments are the opportunity cost of your money. For example, a huge car loan might prevent you from getting the home loan you want, or the massive home loan might prevent you from making a career change.

Okay, so how do I sort my debts?

List all outstanding debt you owe

Grab a piece of paper and a pen and write down the outstanding balance of all personal debt that you currently owe. That includes credit and store cards as well as any other personal loans. Next to each outstanding balance, jot down the interest rate that you are paying on that debt.

Check out what else is on offer

When you see it in writing, you could be surprised by how much interest you are paying on some of your loans. Canstar analysis shows that the average credit card interest rate is in excess of 17% – even the average car loan interest rate is currently in excess of 9%. So check out what else is on offer. Click here to compare credit cards, click here to look at balance transfers. Click here to compare car loans and here to check out other personal loans.

Think about consolidating your existing loans

How many credit cards do you have? How many car or personal loans? The more loans you have, the more difficult it is to keep track of them all, so consider whether any of your loans could be consolidated together – preferably onto a lower interest rate.

Work out your repayment plan

The most important thing when it comes to personal debt is to have a plan to pay it back at some point! Try our personal loan repayment calculator  to put an affordable plan in place.

Be realistic

Debt usually doesn’t appear overnight; it gradually builds up over time. And likewise, paying it all off happens gradually over time as well. It’s important to reward yourself along the way and to avoid feeling overwhelmed about it all.

Are you struggling with the repayments?

Whatever the type and opportunity cost of your debt, if you’re struggling with the repayments now in our low rate environment, you need to do a detailed assessment of your financial situation. It may be that your debts levels are fine and you just need a better budget – work it out sooner rather than later though.

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