Now’s a really good time to focus on debt reduction
With the official cash rate at 1.5%, and possibly going even lower, now’s a good time to avoid being overcome by debt.
With more that $1 trillion owing on mortgages and credit cards, Australians have just overtaken the Swiss as the world’s most personally indebted people.
Adult Americans, usually considered most likely to owe more than anyone else, are an average US$45,000 in debt compared with the equivalent US$56,000 for each adult Australian.
If you’re one of the millions of Australians with personal loans, especially if they’re helping to keep you in business, then you have added incentive to try and escape drowning in the rising flood of our country’s outstanding household debt already at 125% of GDP.
It’s a situation worsened for far too long by politicians of the major parties. In trying to win enough votes to keep their jobs, they’ve condemned Australians to live in an economy that requires debt to grow more quickly than income, thus creating growth that electors will accept as normal.
However, Macks Advisory believes now’s not the time to be distracted by media inspired clamor about unsustainable State and Federal governments’ debt, but instead to focus on reducing your own debt that could well become unsustainable in looming difficult times.
Private debt’s the greater worry
Successive governments in Canberra and State capitals have been justifiably admonished during the past decade as public debt tripled to about 34% of GDP.
But private debt that’s doubled to some 160% of GDP over the past 20 years is by far the greater worry. However, it wasn’t even mentioned by any party during the recent election, let alone raised as an issue. Yet with increasing numbers of economists and business analysts predicting that Australia is headed for a recession, private debt is obviously very much an issue for millions of Australian households.
If you’re a householder in debt – especially if it’s substantial debt and you’re investing in real state or running a business – then you should reject the theory that banks will adjust to the need to lend to businesses so the money can in effect be reinvested in the economy.
For in reality in the past 20 years they’ve mostly been lending to householders buying residences for themselves or as investments. By the end of the first quarter of this year banks’ stock of business credit ($852 billion) had dropped from a half to only a third of total lending.
In just the past five years, combined owner-occupier and investor loans outstanding have risen from $1.2 trillion to $1.6 trillion, and in just the first quarter of this year gross national income shrank 0.4% while housing credit increased 7.2%.
If forecasters are right, and Australia slips into recession possibly by the end of this year or at the latest sometime in 2017, then real estate prices will drop to an extent that many highly geared owners will be in very serious trouble.
Borrowers should cease the day
So, cape diem if you’re a borrower – especially if it’s a home loan and you’ve been delaying switching to a cheaper one, thinking costs could exceed savings? Have another think. A new lender in the current economic climate is likely to waive start-up costs, and interest saved could be eye watering.
If you want to open a new loan you need to look for a lender with a competitive track record offering a rate certainly more competitive than the big banks. We’ve seen examples of borrowers taking out an $800,000 loan with just such a lender in January last year who could already be more than $5000 better off than anyone who took a similar loan at the same time from a big bank. That saving, over 30 years, could escalate to some $109,000.
At the time of writing this newsletter loan discharge fees averaged $268 and the average fee to establish a new loan was $419 – on which most lenders were willing to negotiate.
Even where a switch cost applies, most borrowers these days find interest savings will recover it within a year. But bear in mind if you have that $800,000 variable home loan with one of the major banks at say 4.5% and want to switch lenders, you’ll need to sign up for a rate of 4.38% or lower.
The credit card interest trap
There are encouraging signs that increasing numbers of Australians are aware of the credit card interest trap. Reserve Bank of Australia (RBA) data shows the nation’s overall credit card debt that attracts interest charges has dropped 11% in the past four years, saving them a total of $700m.
However, Australians are still paying interest on $32 billion of a current record total of $52.2 billion of credit card debt, which contributes substantially to their record of having the world’s highest personal debt.
There’s an average of $4,300 owed on every credit card now operating in Australia and Australians at credit card rates of between 15% and 20% are paying an average $700 annually on their credit card debt.
The good news according a Finder.com.au analysis of the RBA data is that average credit card balance attracting interest has dropped in the past four years from $2471 to $1992. The bad news is that the number of credit accounts in the same time has jumped 15% to 16.5m as consumers spread their debt across more credit cards.
But remember this: the interest on standard credit cards is almost 20%, for personal loans around 10% and for mortgages about 5%, which means the cost of $10,000 owing on a credit card can be some $2000 annually – about four times what it’d be if owed on a home loan.
If you pay the closing balance owed at the end of each month on a credit card, you’re paying no interest.
But someone like Bill (not is real name) is caught in a credit card trap. He owes $5,000 on one of the big banks’ credit cards that have an average interest rate of 19.82%.
He’s resolved to do something about this situation and pay off the debt with a monthly payment of $250, which will cost him $5998 and take him two years. If he’d been paying 8.99% on one of the less expensive cards, the cost over two years would have been $5441, a saving of $557.
At least he wasn’t so stupid as to decide to pay off his $5000 debt with only the required minimum monthly payment which, with his high-rate card would have taken 44 years to pay off, and cost him $23,453. Making the minimum payment on a card with a rate of 8.99% would still have taken 16 years and cost $7625.
If you decide to act on Macks Advisory’s recommendation to reduce debt now, be sure to do everything possible to do it on terms most favourable to you.
For more information, contact Macks Advisory on 08 8231 3323 or visit our office on Level 8 West Wing, 50 Grenfell Street, Adelaide SA 5000.
