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Debt Management 

During this quarter’s email, we are going to discuss some simple debt reduction strategies, why?

Well, reducing your debt may help increase savings, because you will pay less interest over the life of the loan and once your debts have been fully repaid, your past repayment amount now becomes SAVINGS. Now, by focusing on reducing debt and not just making minimum repayments, you will tip the scales and begin to find yourself with significant cash-ola which can aid you to become debt-free, even asset rich.

Here are some strategies that can help you to slash your liabilities; make additional repayments, consolidate your debts, repay debts with higher interest rates first, and repay non tax-deductible debt before repaying tax-deductible debt. Let’s talk about them individually, I’ve even made headers for each so you can jump straight to the one that grabbed your attention :)

Additional repayments

Making extra repayments on your loan can help eliminate your debt faster and save on interest costs. Even a small increase in your repayments may provide you with significant savings over the life of your loan. Any lump sums you receive, such as tax refunds or bonuses, could be directed to your loan.

Putting your additional repayments into an offset account or redraw facility gives you the benefit of the reduced interest cost plus the security of knowing you can access the money again if you really need it. If your loan doesn’t have an offset account or a redraw facility, it may be worth checking with your provider to find out if this feature can be added to your existing loan.

Consolidate your debts

Consolidating your debts into one loan may help save on interest costs, if, your higher interest rate loans i.e. credit cards and personal loans can be consolidated onto your home loan which should have a lower interest rate.

To implement the strategy, you will need to increase one loan facility i.e. your home loan and use the funds to repay your other debts. The next part is important, you must continue making the same overall loan repayment on the remaining loan after consolidating otherwise it will take you longer to repay the debts and you could end up paying more interest over the life of the loan.

Repay high interest rate debt first

If you have more than one loan, chances are that the interest rate applying to each loan will be different. As a rule and generally speaking, credit card loans have the highest interest rate, personal loans next, then your home loan.

It is important that you continue making the required repayments on all the loans whilst using surplus income to repay the higher rate loan first.

Repay non-deductible debt first

The interest on loans that are used to buy an income-producing asset i.e. shares or an investment property is tax-deductible. This is called ‘deductible debt’. The tax deduction effectively reduces the cost of the debt, with the value of the deduction being higher if you are on a higher marginal tax rate.

‘Non-deductible debt’ is a loan that has been taken out to buy a non-income producing asset i.e. your home or car, or to pay for personal expenditure, such as a holiday. You are generally not eligible for an income tax deduction for the interest on these loans so these debts should be repaid as quickly as possible.

To accelerate the repayment of the non-deductible debt you could:

  • use your surplus income to make additional repayments
  • halve your monthly repayments and repay this amount fortnightly instead – this results in you making 26 repayments for the year, equating to 13 months instead of only 12
  • change the repayments on your deductible debt to interest only to increase your surplus income and direct this income to repay your non-deductible debt more quickly.

What are the benefits?

The benefits of a debt management strategy may include:

  • the potential to increase your wealth once debts have been repaid.
  • paying less interest over the life of your loan.
  • reducing your financial burden.

Risks, consequences, and other important things to consider

These include:

  • Before making any changes to your loan, you should check what fees and penalties may apply.
  • Some loans do not allow additional repayments to be made. You should check with your loan provider whether additional repayments are allowed and whether any penalties apply.
  • You should have adequate life insurance to help meet loan repayments or payout your debt if your income stops because of death or illness.
  • You should check with your accountant before making changes to investment-related borrowings.
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