Savvy with your money: Dig yourself out of debt and stop borrowing

Savvy with your money: Dig yourself out of debt and stop borrowing

Consumer debt has increased at a frightening rate in the past few decades, even though it has never been more expensive

The greatest threat to your financial well-being is borrowing. I am not talking about reckless borrowing, either, but ordinary borrowing in the form of personal loans, overdrafts and credit cards. This is because the cost of borrowing money is a huge drain on your most valuable asset — your income.

What’s more, the cost of borrowing can’t just be measured in terms of the interest you are paying. You must also factor in the opportunity cost — the money you would otherwise be making if you were investing your income instead of spending it on servicing your debts. Let me give you one simple example:

€10,000 repaid over seven years at an interest rate of 10% will require monthly repayments of €166. Total interest cost €3,945.

Invest €166 a month into say the stock market for the same period and, assuming the same sort of growth as we have seen over the last 10 years bar the last few, you’ll have a lump sum of almost €20,000 in seven years.

Which is why, I always emphasise the benefits of being debt-free, together with two proven methods to make paying off all your loans fast and painless.

You may not even realise you have a problem

Most people borrow money but fail to think of themselves as being in debt.

The fact is:

  • You don’t have to be in any sort of financial difficulty to be in debt.
  • When you add up the cost of servicing your debt — including your mortgage — it may come to more than you imagine.
  • Debt is the single greatest threat to your financial freedom and security. It is sucking away your most valuable asset: your income
  • The first benefit of being debt-free is that your money becomes your own to spend or invest as you prefer.
  • Not having any debt will make you less vulnerable. You won’t need so much insurance, for instance.

Over the last 20 to 30 years consumer debt has increased at a frightening pace. Why should this be?

Some borrowing is unavoidable — for instance, loans taken out when ill or unemployed. Some can be attributed to other factors such as changing social values, lack of education at school, our consumer society and ‘impulse’ spending.

However, I believe the main reason for the borrowing boom is that debt has become a hugely profitable business.

Bluntly, lenders use clever marketing tricks to ‘push’ debt onto innocent consumers. They are doing this because the returns are irresistible. Look at how much money they can make:

  • If you leave money on deposit at a bank you’ll typically earn less than 1% (€1 for every €100) a year by way of interest.
  • That bank, however, can lend your money to someone else at anything up to 24% (€24 for every €100) a year.

Under the circumstances, is it any wonder that financial institutions are falling over themselves to lend money? Or that they devote themselves to coming up with new ways to sell loans to their customers?

Debt comes in many disguises

The trouble with the word ‘debt’ is that it has all sorts of negative connotations. Many people believe that providing they are never behind on their repayments they are not in debt. This isn’t true. A debt is when you owe someone money.

It could be:

  • an unpaid balance on a credit card
  • an overdraft
  • a personal loan
  • a car loan or loan for some other specific purchase
  • a mortgage on your home
  • a secured loan
  • a hire-purchase agreement
  • an unpaid balance on a store charge card
  • a business loan
  • a loan made by a friend or family member

It is important to remember that just because you are never in arrears and have an excellent credit rating, it doesn’t mean you are debt-free.

First steps for getting out of debt

There is one thing you must do before you set out to eradicate all your debt — stop borrowing.

After all, you can’t get yourself out of a hole if you keep digging. Take a once-and-for-all decision to:

  • not just to pay off your debts, but to stay out of debt
  • not to borrow any more money unless it is absolutely unavoidable (or there is a very reasonable chance that you can invest the money you borrow to make more than the loan is going to cost you to repay).
  • not to live beyond your means
  • avoid ‘bargains’.

Something that you don’t need but you buy because it seems to be cheap is definitely not a bargain.

There are various actions you can take to make this easier on yourself. You can:

  • Cut up all your credit cards and store cards
  • Cancel your overdraft limit.

But remember, most banks will allow a ‘shadow’ overdraft on your account. This means that informally they may allow your account to overdraw by say €500 before you are contacted. This is costly and may eventually have to be formalised, so you are back in the overdraft trap again. Keep track of all transactions on your account.

  • Use a charge card where the balance has to be paid in full at the end of each month or take the prepaid card option.
  • Avoid buying any unnecessary items.
  • Do not take out any new loans, including hire-purchase agreements and overdrafts
  • Do not increase the size of any existing loans
  • Pay with cash whenever possible (nothing reduces one’s tendency to spend money as paying with cash).

Taking stock

Once you have stopped making the situation any worse, you need to take stock of your situation. In particular, you want to gather together full details of your debts.

The information you require about each of your debts is:

  • to whom you owe the money
  • how big the debt is
  • how long you have to pay it back (the term), if relevant
  • what the rate of interest is and whether it is fixed or variable
  • whether you will be penalised for paying back the debt early (and if so what the penalties are)
  • what the minimum monthly payment is (if this is relevant)
  • whether the interest is calculated daily, monthly or annually.

Obviously, it is important not to overlook any possible debts, so here is a quick checklist to remind you. Don’t forget to include any money that your spouse or partner may owe too.

Consumer debt has increased at a frightening rate in the past few decades, even though it has never been more expensive

Seven reasons to be debt free

Here are seven reasons why you should pay off all your debts — including, perhaps, your mortgage.

  • 1) It will make you less vulnerable. If you are in debt and for some reason your income is reduced or stops altogether (suppose, for instance, you fall seriously ill and don’t have permanent health insurance), then not being able to repay your loans could have serious consequences.
  • 2) It will make your family less vulnerable. I don’t want to depress you but when you die your debts won’t die with you – your estate will have to pay them all.
  • 3) You won’t have to worry about inflation. If you owe money and interest rates rise (as recently as 1981 interest rates were as high as 20%) then you could easily find yourself struggling to make your monthly payments.
  • 4) You won’t have the stress which comes with debt. The fact is that owing money is stressful.
  • 5) You’ll enjoy a genuine sense of satisfaction. There is a real peace of mind which comes with not owing money and with owning your home outright.
  • 6) It will open up new choices. Suddenly all the money you are spending on servicing your debts will be available for you to spend or save as you prefer.
  • 7) It will ensure you have a comfortable retirement. Furthermore, it may allow you to retire early. Why should you have to wait until you are 60 or 65 to give up work?

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