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We all know getting into debt isn’t really desirable. So are there times when borrowing is justified? And what’s the best approach to keeping repayments within reasonable limits? We spoke to CFP® Sandy Hopps from Strategic Planners to get expert advice on smart ways to borrow money.
Recent reports and statistics show we’re no strangers to debt in Australia. According to OECD data from 2015, Australia is 4th in the world – behind Denmark, the Netherlands and Norway – when it comes to the amount of debt we have as a percentage of our net income. These figures also show that with the average level of debt we’re accumulating, we’re spending more than double our income each year.
If that’s not alarming enough, this is a trend that’s showing no sign of slowing down. Data from the latest Australian Bureau of Statistics Household Income, Wealth and Expenditure Survey has seen the average amount of debt per household double in the last 12 years, from $94,100 in 2003-4 to $168,600 in 2015-16. Although a lot of borrowing is for buying property, 55% of Australians hold credit card debt compared with 34% who have a home loan.
We spoke to CFP® Sandy Hopps to get her expert advice on what kind of debts are best avoided and how you can make smarter choices when it comes borrowing.
Good vs bad debt
There are certainly ways to borrow that can be beneficial and others that you really should try to avoid. Using some kind of loan to buy consumer goods or depreciating assets – like a new car or home appliance – is always going to be a financial setback. You’ll be out of pocket for the cost of what you’re buying, plus the cost of borrowing. And there are so many ways to borrow now – credit cards, after-pay, interest-free finance – it’s very hard to resist the temptation to buy now and worry about all the fees and interest payments later.
If you’re smart with savings and planning your finances, you can get to a point where you can afford things and still live within your means. Let’s say you invest the money you’d spend on repayments on a car loan. Over time, the earnings from that investment – and potentially it’s value – will accumulate to the point where you’ll have extra money to spend on the car, holiday, school fees or whatever will bring better quality of life to you and your family.
Positive outcomes from property
When it comes to getting ahead financially, there are certainly benefits to borrowing to buy your own home. By building up equity in that home over time, or by renovating an older home in a popular location, you can quite easily move your financial situation forward. And as you’re giving yourself a roof over your head, you’re doing all this while meeting your need for a secure home.
With the property boom we’ve been having in Australia, it’s easy to forget property values can go down as well as up. If you’re buying a property to live in it’s certainly something to be aware of when you’re deciding how much to borrow. But when you’re buying to invest it’s even more important to bear in mind what will happen if you can’t get tenants or find that you need to sell sooner than expected. And you’ll also need to consider the initial cost of your investment and whether you’re prepared to have your money tied up and make a commitment to loan repayments for at least seven years.
I’ve advised a number of clients who have already taken the plunge and taken on investment debt. They’re often acting on well-meaning advice from family or friends and feel like they’re falling behind financially if they don’t take action to boost their wealth. But there are questions they need to answer before making a commitment to borrow and invest. Have they got the risk tolerance for the size and type of investment they’re taking on? Do they have enough to cover all their costs? Are the tax savings from the gearing strategy going to outweigh the total cost of borrowing and investing?
Budgeting to borrow
No matter how much you’re borrowing or what it’s for, there has to be a surplus in your cash flow to cover repayments for the life of the loan. People often underestimate just how much they actually spend from month to month so I’ll always do a proper audit of client’s accounts to understand their real cash flow and budget position. And if you can afford repayments now, interest rates – just like property values – can change. Interest rates in Australia have been low for a long time now and can only go in one direction from here. Any borrower needs to ask themselves what sort of impact it will have on their finances if interest rates – and repayments – rise.
Be ready for change
Losing some of your income can also have an impact on your capacity to meet repayments. If you’re unable to work for a while, it can be a challenge to cover all your expenses from your saving. Taking out personal insurance – such as an income protection or trauma policy – can help you keep up with repayments if you suffer an injury or illness that stops you earning.
Having flexibility in your loan arrangements can also help when life gets in the way of earning money. Many loan providers offer redraw facilities so you can pay more off your loan now and then have access to the extra funds later. Others offer payment breaks – usually limited to several months’ duration after you’ve held the loan for a number of years. But it’s important to remember that interest keeps adding to the amount you owe during the payment break, so you can expect to be making larger repayments when the break is over. Plus you’ll be paying more interest overall for the life of the loan.