‘The Big Short’ on the True Cost of Debt

Margot Robbie explaining debt whilst enjoying her Champagne

8 ways debt can affect your financial well-being, relationships and psychological health.

We all know that we have to pay interest when we take out a loan. It’s the price we pay to use someone else’s money to purchase something we don’t have the cash for today.

But beyond that, most of just don’t realise what the true cost of debt can be.

We don’t really consider the long-term financial impact of taking out a loan, not to mention the emotional and economic toll our debts can play on our lives.

The question of money and happiness has long been debated. Money in itself of course does not buy happiness, yet our financial decisions do indeed impact on our ability to live our desired life. It is here that we can positively affect not only the financial decisions and tangible outcomes for ourselves, but also the intangible aspects.

One of the most compelling statistics to emerge from research on this is that those who receive ongoing money management & debt advice are;

22 per cent more likely to feel as though they are living their ideal life.*

Money, Health and Happiness

Research by IOOF [White Paper, The true value of advice. 2015]* uncovered significant emotional benefits experienced by clients who have a financial plan and who receive professional ongoing financial care compared to those consumers who do not. These included having:

• 13 per cent greater levels of overall personal happiness

• 21 per cent more peace of mind with regards to their financial future

• 20 per cent increased feelings of security regarding their day to day finances.

Perhaps even more importantly, the research found that these clients experience additional positive social and personal benefits, compared to individuals who don’t. They found that these clients are:

• 19 per cent less likely to have arguments with loved ones about money

• 21 per cent less likely to have their personal relationships impacted due to concerns about money.

It was also discovered that consumers who don’t have a financial plan or receive professional ongoing advice and care are 22 per cent more likely to have their sleep disrupted due to concerns about money.

Knowing what’s valuable to you has never been more important. From a monetary perspective, evidence concludes that you will have positive emotional benefits that reach beyond the provision of a successful financial plan.

Here are eight ways debt can affect your financial well-being, relationships and psychological health.

1. Interest reduces your household budget

Debt offers only a temporary increase in your purchasing power. You can now buy what you want, paying it off over time from future earnings. It’s important to understand, however, that the downside of this approach is that your future earnings are now going to be spread much thinner.

If you are carrying an average balance of $5,000 on your credit card at a 21% interest rate, this ‘revolving debt’ is costing you more than $50 a month in interest charges. Over a just one year, this adds up to more than $600 in money spent on interest, rather than necessities or savings.

The danger this presents is a cycle of credit creep. As your credit card debt increases, your interest costs and minimum payment requirements rise. If your income isn’t increasing, interest begins to consume a bigger and bigger percentage of your take-home pay every month, making you even more dependent on credit to make ends meet.

The solution is to reverse this cycle. Pay off all debt, no matter what kind, as fast as possible. If you are carrying credit card debt, take a cold hard look at your discretionary and fixed and find ways to increase your debt payments to reduce your balances faster.

2. Longer Loan Terms are Not Always Your Friend

When you have to borrow money, look for the cheapest ‘whole-of-term’ option available. This means looking at the total cost of the loan over the term of that loan, not just the monthly payment.

Let’s consider an example. You wish to refinance your $395,000 home loan currently at 3.55% to reduce your monthly repayment of $1,988.07. You currently have 25 years remaining on your existing home loan.

Your mortgage broker proposes a new loan of the same amount and the bank agrees to loan of $395,000 at the SAME interest rate (3.55%) but now, over a thirty year term. That equates to a new monthly payment of $1,784.77. That reduces your monthly commitment by 203.30 per month. Is it a better deal?

The truth is to lower your payment, the loan term was extended. Over the ‘whole-of-term this option will cost you an EXTRA $46,095.68 in interest costs! Not just that, you have a further 5 years of loan repayments that would restrict you from being able to invest into your retirement – and remember you’ll be 5 years closer to that desired retirement date.

You are better off in the long run taking for the shortest loan term you can. The faster you pay off any credit, the less you pay in interest. If you need to lower your monthly payments, reduce your expenses and pay your debt off faster.

3. Debt makes it harder to Save

Debt prohibits your ability to set money aside. Whether this is because your debt repayments are taking up too large a portion of your income, or because you don’t think savings are important right now, doesn’t really matter. The end result is the same. Little savings and lots of debt.

Easy access to relatively cheap credit provides little incentive to save for a rainy day. These days. In Australia, our savings ratio has fallen to 3.2%, meaning for every $100 we pocket after tax we're saving just $3.20. It's not enough to fund more than a few Freddo Frogs, yet just three years ago we were saving three times this amount. In the 1970s, Australians were tucking away more than 20% of household income.

The fact is we've lost our savings mojo and in many cases we confuse genuine savings with just money being accrued for our delayed spending (Example: Saving to go on a holiday).

A recent survey by ING they reported that two-thirds of Australian households could not easily raise $3000 for an emergency, and one in four Australian households have less than $1000 in savings.

Guido Swinkels, ING Australia's savings product manager said, "What was even more concerning is that 92% said they would rely on some form of borrowing to deal with a short term crisis.

A good long-term financial plan provides for both the repayment of debt and the build-up of savings. Begin by preparing a budget that improves your cash flow surplus.

Having savings to rely on while in debt helps keep you motivated. Let’s say you’re paying off $1,000 each month against your $20,000 credit card debt with a goal to be out of debt in two years. There is nothing more disheartening than finding out you have to divert this month’s debt repayment because you need to pay the plumber or your car mechanic for an unplanned repair.

4. Debt controls Freedom of Choice

One of the biggest emotional costs of carrying debt is that you no longer have the finances to do what you want. If you are carrying a lot of debt, you can’t afford to take a vacation, you avoid going out; you terminally feel pinched.

Even good debt limits your freedom of choice. Carrying a large mortgage on a home limits your mobility. Many saw this play out during the financial crisis. Relocating for a new job means selling your house where you live today. Even with the slow recovery we are now experiencing, the sales process can take longer than you expect, and force you to accept a price that may, or may not, repay your mortgage and provide you with enough of a down payment on a new home.

If a significant portion of your monthly income is tied up in debt payments, what happens when something goes wrong? Your debt load might be manageable today, but what happens when you, or someone in your family loses their job, becomes ill, or passes away?

This lack of freedom can lead to more bad financial decisions. When credit card repayments are already taking up 20% to 25% of your income and you need a new car, what do you focus on? That dreaded monthly payment again. That means you look for any option that will permit you to keep up with a new car loan or lease payment. You may be forced to deal with a lender who offers low credit score loans. The downside is higher interest costs, and potentially higher fees as well.

5. Debt Delays Retirement or reduces retirement income

One of the fastest growing risk groups in terms of bankruptcy are pre-retirement debtors. These are individuals aged 50-59 who suddenly find their retirement plans set aside as they continue to struggle to make huge monthly debt payments.

Despite a higher than average income, there are more demands today on the average 55 year old. Sandwiched between children education costs, adult children forced to stay or return home, and aging parents; they find their income stretched further than they ever anticipated.

While every person’s retirement needs will differ, few will be able to live comfortably without any supporting savings.

If you are carrying debt into your 40’s and 50’s, you’re likely facing a retirement hurdle you possibly can’t surmount.

The sad truth is, most never plan for this to be the outcome. What happens is they wake up at 55 and ‘suddenly’ find themselves buried in debt and forced to consider down-sizing or eating into their retirement savings to pay out their remaining debt.

6. Debt Has an Unexpected Life Cycle

Regardless of age, one of the largest inherent costs of carrying debt, any debt, is the added risk factor when things go wrong. This is what, for more than 32,000 people a year in Australia leads to bankruptcy.

Research shows that it is the unexpected life event that often triggers the need to file bankruptcy. Most expect to pay off their debt. Often they are surprised to find out they cannot.

The top causes of bankruptcy, beyond financial mismanagement, are unplanned life events.

Even with government safety nets and personal insurance, illness and injury is one of the most often cited causes of bankruptcy. It’s not just the obvious costs of medical bills either. When you are sick or injured, you can’t work. Without a stable income you can’t pay your bills.

At first you turn to credit cards just to make ends meet, fully expecting to be able to pay these debts off once you do return to work. But what happens when you don’t return to work or return to a limited income and continued medical costs?

Income reduction is also something never planned or thought out. And this doesn’t have to be an event as severe as a permanent job loss. Your work hours may be reduced, or a spouse may take time off to have children. If you are carrying debt, and have no emergency fund, you are unlikely to be able to keep up.

Default adds penalties and fees, increasing your debt costs. If you’re not able to return to work at a similar income level, you may find yourself unable to stop creditors from pursuing you legally without filing bankruptcy.

Unfortunately, using credit as a temporary stop-gap often becomes a permanent problem. Just $200 a month charged to a credit card for groceries, gas, bill payments, or whatever else you need while your income is reduced, balloons to a balance of more than $2,200 in just 12 months. You would have to pay an extra $110 a month to pay this off within 2 years. And that’s assuming you didn’t have credit card debt to begin with.

7. Debt, Happiness & Divorce

Carrying too much debt adds to the strain in a personal relationships and marriage. While not all families with debt will end up divorced and partnership break up, and while separations are not caused by money problems, there is definitely a correlation between debt and divorce.

More than one-quarter of all bankruptcies we see are for individuals who are divorced or separated at the time they filed bankruptcy. And almost 1 in 5 cites a marital breakdown as the primary cause of their bankruptcy. It’s easy to see why. Debts you could barely afford in a two-income household become unmanageable when you separate.

While debt doesn’t necessarily equal divorce, it certainly adds to the risk and adds to the complications of settling up in a divorce or separation. Joint debts, loans owed by both spouses, need careful legal planning in a divorce. Examples would include a mortgage or bank loan where both spouses signed for the loan. Even joint credit cards can lead to one spouse becoming liable when they did not expect to.

In the case of joint debts, both spouses will remain liable unless the original lender agrees, in writing, to remove one party. A divorce or separation agreement by itself cannot absolve one spouse of their legal obligation under a loan agreement.

Debt Just Complicates Things

Simply put, debt is complicated. Yes, you will pay interest — but you will pay much more.

• Debt grows faster than you expect.

• Debt takes longer to pay off than you expect.

• Debt adds risk when life throws an unexpected curveball.

• Debt can lead to unhappiness and unfulfilled life goals

All of this puts your future at risk. If you are going to take on any debt, look beyond your present-self and your monthly payments and factor in your future-self. Make sure you don’t pay for your debt for the rest of your life.

The Best Solution

“The Big Short on the True Cost of Debt and Living your Ideal Life”

FutureNOW is market leading financial software, developed by Rarebreed Technologies, its algorithms apply incontestable money logic and can demonstrate amazing results with only the money you have now!

FutureNOW looks carefully at your cash flow and debt today and projects outcomes toward your future retirement, identifying how managing your money today more cleverly can improve your savings, financial net wealth and retirement income.

The FutureNOW principles and logical priorities are:

1. Learn your cash flow movements and spending behaviours – without this knowledge it will be difficult for you to establish and maintain your Cash flow budget and understand your “consumer behaviours”. I can help you with this.

2. Set simple, practical and realistic budgets on your expenditure with the absolute intent to ensure you have greater income than expenditure. Know what you earn and how you spend.

3. Within your budget, ensure that you retain a cash flow buffer, recognising that your cash flow (inflow and outflow) will have its up’s & downs and that it is wise to have available “cash at hand”; enough to insure you against life’s misfortunes, breakages and inflation.

4. Use simple and cost efficient banking and loan structures with effective use of Offset accounts and FutureNOW money management strategies.

5. Next, and importantly, rid yourself of high interest personal debt using FutureNOW’s Cascade strategies.

6. If you have other life goals (with priority over paying down your Home Loan) that require savings then save for That “Big Hairy Audacious Goal”, now. Examples of these are building savings before taking time off work to have a Baby or returning to study and still managing whilst your income is less.

7. Pay your Home Loan off as soon as possible using the FutureNOW money management plan.

8. Invest in your retirement, over and above your Superannuation Guaranteed Contributions, as soon as you are able and can afford to.

With smart credit advice and Rarebreed’s exclusive FutureNOW money management plan they’ll help you get closer to your future-self, and your future opportunity, so you are more likely to save for retirement, make healthy decisions, and avoid rash spending behaviours.

Rarebreed & FutureNOW can set you up to cut years off your debts and save you thousands in interest costs so you, can enjoy life now and look forward to a better future.

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