Use interest rate cuts to slay your debt monster

Money has never been cheaper. So use this opportunity to reign in your debt monster.

The Reserve Bank this week cut the official interest rate for the second consecutive month to a historic low of 1 per cent. While the banks haven’t passed on the full rate cuts they have slashed borrowing (and savings) rates.

Rather than see these cuts as a windfall for the household budget, use the opportunity to redirect those savings to paying down debt. Because while interest rates are falling, the debt levels of the average Australian household is still dangerously high.

While credit card usage and outstanding balances have fallen, they are still uncomfortably high as are mortgage levels as a proportion of income. So let’s get debt savvy by putting interest rate savings to good use by paying down debt. 

Did you know that by simply making the minimum monthly payment, you are not actually making a dent in the debt? That’s because banks dropped the minimum payments from 5 per cent of your outstanding balance to just 2 per cent… no wonder that minimum payment seemed easier to make.

Before you start thanking them think about this. If you simply paid the minimum monthly balance on a $2000 credit card balance, it would take 25 years and 9 months to pay off the debt and you would have paid $3671 in interest. 

BUT pay an extra $100 a month on top of the minimum monthly balance and the debt would be cleared in just over 2 years with interest of $355.

What they show is that many people get into trouble because they don’t understand how their credit card works.

To choose the right credit card, the interest rate has to be weighed up with any annual fee and the conditions attached to any interest-free period. Then there are increasing numbers of extras attached to credit card accounts, as banks vie for your business in the more competitive credit card market.

Two cards from the same bank may have entirely different conditions. However, if you can find your way through the plastic jungle the benefits can mean minimising the cost of using credit while making the most of its convenience.

People generally use credit cards for one of two reasons. They are used purely as a convenient payment mechanism with the debt usually paid off when the monthly statement arrives. Or they are used as a credit facility to fund purchases which usually means a continuing outstanding balance.

No matter what your spending patterns be aware of how the banks will charge interest on any credit card debts. Do not take any interest-free period at face value. 

The biggest catch with credit cards is the interest-free period and the way in which interest is calculated when you exceed it. If looking for a credit card with an interest-free period, make sure you understand just how interest is charged.

While offering a 25 day interest-free period, on some cards if full payment is not received in that time, the interest-free period is sacrificed on future purchases. You get no interest-free days if you haven’t paid the previous outstanding balance IN FULL.

And when you don’t pay the outstanding credit balance in full by the due date, interest can be charged in various ways. Beware especially the cards which hit customers with interest right back to the date of purchase if full payment is not received by the due date on the statement. 

Other banks charge interest from the date a purchase shows up on the statement and some from the date the statement is issued. Check out the terms and conditions of any credit card account you consider. 

The best way to avoid credit charges, whatever they are, is to pay up promptly. This means all outstanding charges on the statement, not just the minimum repayment required on the bottom of the statement. 

ASK YOUR BANK FOR A BETTER RATE

“Only mugs pay retail,” is the slogan of many keen shoppers. Don’t just bargain for a better deal at the shops, do at the bank as well. All they can say is no but I reckon you could be surprised at what happens.

Go to the bank manager and ask for a better rate on your home loan. If you’re a good customer with credit cards and insurance policies with the bank, they’ll usually do something for you.

I mentioned this on Sunrise a few months ago and my colleagues put it to the test and were stunned when the bank lopped a quarter per cent of her home loan rate.

When they asked the bank manager if he would have done the same if they’d asked a year earlier he said… “yep, all you have to do is ask”.

So go do it.

CONSOLIDATING LOANS

A common strategy is to merge your credit card debts and personal loans into a lower interest rate loan, such as your mortgage. 

The beauty of this strategy is that the lower interest rate will apply to all your debts, thereby saving you interest in the short-term. 

However, if all you do is make the lower repayments, it could actually take a lot longer to pay off your debt. 

As a result, you could end up paying more interest over the life of the loan, despite the lower annual interest rate.

To really benefit from loan consolidation, you should consider maintaining the same monthly repayments and use the interest savings to help you pay off your debt faster.

SWITCHING CREDIT CARDS

There’ve been plenty of financial commentators who’ve done the sums and figured out that it IS possible to keep transferring your credit card balance between the plethora of new card providers offering zero per cent interest for 6 or 12 months.

Be aware though that every time you apply for a new credit card it goes on your record… and can affect your credit rating. The information is provided to potential lenders who can’t see WHAT you’ve done with your cards only how many you’ve applied for. 

So, on your credit rating it may LOOK like you have 10 credit cards because the system also doesn’t show how many cards you’ve cancelled.

It could end up with you being rejected for a loan because the bank gets the impression you can’t handle debt.

INCREASING THE FREQUENCY OF MORTGAGE REPAYMENTS

One of the most popular steps to help pay off your mortgage sooner is to pay fortnight instead of monthly… because over a year you make one additional month’s payment.

If you want to do this, make sure your lender is clearly aware of what you want to do.  If you simply front up to the counter and ask to switch from monthly to fortnightly, all they’ll do is recalculate your payments so you’ll still take just as long to pay it off.

It’s also possible your lender will take into account any extra repayments you’ve made and reduce your repayments even more to fit the agreed life of the loan.

The easiest thing to do is half your current monthly payment and tell the bank THAT’s the new figure you want to pay each fortnight.

REPAYMENT HOLIDAYS

A lot of people choose home loans with flexibility, to allow them to change repayments depending on their financial circumstances.  What many don’t realise is that lenders often have ways of recouping the costs of offering this “flexibility”.

Around 70 per cent of Australians make extra mortgage repayments. Often people do this because they think it will afford them protection should interest rates go up – or if they can’t afford repayments for a period due to loss of income.

Check your contract though. Some lenders will offer a loan “holiday” but will actually then recalculate your repayment schedule at the end – based on your overpayments… effectively increasing your regular payments.

Be careful too about redraws. Even if you HAVE made overpayments some lenders will refuse to let you take those repayments back if you lose your job… keeping them for their own security.

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