Not all debts are the same. While some debts actually help develop your asset base and can make you wealthy over time, other debts are like a cancer, growing slowly but surely to ultimately destroy everything that you work so hard to build.
Replacing bad debt with good debt can take many years of concentrated effort. It is much easier to make correct debt decisions from the outset.
Debt habits form and early age
We learn spending and saving habits from our parents. If we have come from a family that did not believe in investment, a family that was always struggling with debt, always short on money, it makes it far more difficult for us to make wise financial decisions in our early 20s. Everyone needs to have a role model when it comes to money management.
Too many young Australians borrow to pay for holidays, jewellery, weddings and the like. We regularly witness the fallout of unwise debt decisions made in their early 20’s still haunting people in their late 30s.
Our banking system encourages people to live beyond their means. We are offered credit to enjoy things today and pay for them later. Borrowing for a wedding leaves you with a great photo album and a video, and a crippling debt problem to grapple with for years to come. Unfortunately some wedding loans have a longer life-span than do the marriages they financed.
Budget before spending
Any successful investor knows the importance of budgeting. Unless you come from a very wealthy family where access to funding is pretty much unlimited, choices need to be made and money needs to be assigned to “essentials” and the “nice-to-have”.
A budget is a financial plan of how you intend to spend the money that you earn. If you are left short after you have assigned money to your expenditure categories, you clearly need to either find ways to increase your income or reduce your expenses.
It is indeed that simple. If you would like to buy a house by the time that you are 30, a deposit will not magically appear in your account when you turn 29. If you do not put a budget together that allows for you to put some money away towards a deposit every year, it will not happen.
Budgeting helps to make sure that the money that you need to pay for rent, utilities, food and entertainment is set aside and available. Budgeting helps highlight if you are running out of money and assists one to plan for upcoming larger expenses such as a holiday or a wedding.
Effective use of credit cards
Credit cards are a great money management tool. They offer borrowers access to free money for up to 50 days. That means anything you buy on credit, will cost you no interest if you pay the card off in full every month. Anyone who does not pay out their credit cards in full at end of the month is either living beyond their means today or did so some time in the recent past.
If you use credit cards but pay them out at the end of the month in full, then you are demonstrating that you are in control of your money.
If your credit card balance is not being paid out but is in fact increasing, then you are the kind of credit card customer that card providers love. They can count on you contributing lots of money to their bottom line.
The rules with credit cards are simple, if you can not pay it off by end of month, do not buy it!
Borrow to invest
An investment is any asset purchase that you expect to grow in value over time. Most people think of shares or real estate as an investment. However an investment can also be a piece of art or antiques.
The rule with borrowing to invest is clearly the increase in asset value plus any income that the asset is expected to generate over time should exceed the costs associated with its finance.
There is nothing wrong with investment debt. Because this is the debt that helps you grow your asset base and your wealth.
However even with investment debt one needs to be very prudent.
Borrowing with a small deposit can leave you trapped in your current mortgage, unable to refinance to a different lender for a better deal. This is the situation currently facing many Aussie homeowners who bought their homes on 5% deposit during 2008 and 2009. Most of these properties are today worth less than the mortgage debt secured against them.
Those unlucky enough to lose their job while living in a house with negative equity can quickly see their debt problems multiply. If you need to sell the house because you can no longer afford to cover your mortgage payments, there is very likely to be a significant shortfall.
We speak to people who have gone from being homeowners to having no home and being in debt to the bank to the tune of $30,000 after their property was sold. This can be a very hard debt to repay and can push families into bankruptcy.
If you have hit hard times and are finding it difficult to keep up with debt obligations, speak to your credit providers and seek special hardship consideration to help you catch up and recover. Credit providers have a legal obligation to do what they can to assist borrowers experiencing financial hardship.
Looking for assistance from debt consolidation professionals to help you get out of a difficult situation? Please give us a call on 1300 Debt Solutions or visit our website at www.debtsolutions.com.au
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