If you grew up in the 1950’s and 1960’s you will have noticed some major changes in lifestyle choices available compared to what your parents had. One of the biggest drivers of this has been the easy accessibility of credit and the ability of individuals and families to fuel their lifestyle through the use of debt. Our parents paid cash for most things they bought. These days most major purchases are funded on credit with a double income required to support the cost.
At this stage of your life you have probably started to get a handle on your debt situation, whether it’s personal debt or business debt – the mortgage will be under control and hopefully the credit card too. But if you are serious about building wealth for your retirement then getting rid of your debt as soon as possible will allow you to achieve your objective much sooner.
Let’s illustrate the best way to attack this with an example:
Karen is a 51 year old single mother whose two children are now living overseas. She split with her husband six years ago and has continued to live in the family home, which has an outstanding mortgage still owing on it. Jane has a sizeable credit card debt she has accumulated which she needs to repay. She works fulltime and earns $55,000 per annum.
Up until now Karen has been unable to save any money and in fact her credit card balance has been getting worse.
Karen has the goal of clearing the $20,000 of credit card debt and the remaining $50,000 on her mortgage in the next five years. To do so she needs to approach her situation as a three step plan:
- Stop her debt from getting worse
- Consolidate her current situation to bring it under control
- Reduce her debt in the next five years
Stop her debt from escalating
Karen needs to take some steps to stop her situation from getting worse. She is living beyond her means and needs to pinpoint the problem. With the help of a financial planner she works through a budget of her costs and determines where she needs to make eliminations. She is shocked to find that she spends almost $5,000 per annum on eating out and socialising and that her large 5 bedroom home, in which she now lives alone, is costing her $4,000 per year in insurance, rates and maintenance costs. She has been living beyond her income to the tune of $6,000 per annum.
To control her costs Karen decides she will reduce her eating out by half and save $2,500 of her annual expenses. She makes a decision to sell the family home and downsize to one that is more affordable. This allows her to eliminate the outstanding mortgage and not only saves her $1,000 in living costs but also reduces the interest and repayments on the mortgage down to zero, a further saving of $3,000 per year in debt servicing costs.
Consolidate her existing situation
Thanks to the downsizing, Karen is able to clear $3,000 from a garage sale and immediately applies this to her credit card debt. Her credit card debts have been costing her nearly $3,500 in expensive interest repayments so she uses debt consolidation to replace the expensive credit card debt with a lower interest mortgage rate on her home, saving her over $2,200 per annum. She makes a decision to no longer pay for expenses with credit and only buy what she can now afford, preventing herself from blowing out the credit card again after the debt consolidation has freed up her credit balance.
Reduce her debt
Karen now has a small surplus in her monthly living costs, but not enough to make serious inroads into her outstanding debt. She needs to find an extra $2,000 per annum if she wants to get rid of the balance of her credit cards within 5 years.
Her smaller property is a 3 bedroom home and she decides to offer one of the bedrooms as rental accommodation on a peer to peer holiday website to help debt repayment. This gives her the flexibility of taking a break from having people stay whenever she wants as opposed to a permanent. She finds she can easily top up her income by around $10,000 per annum just by having someone staying a week or two per month and she is now well on track to eliminating her remaining debt and building herself a nest egg for the future.
Karen’s situation is just one scenario that may relate to your own circumstances. In reality Karen could have identified a variety of ways of achieving the same result. She may have decided to eliminate other expenses rather than eating out, but she has found she can still enjoy herself by having friends over for dinner at a fraction of the cost. She may have decided not to downsize and instead could have taken in some permanent lodgers to help cover the cost of maintaining the larger house if she had wished. She may also have decided to keep a credit card, switching her balance to a new provider who offered an interest free period while she got her debts lower, or perhaps she may have found an alternative means of supplementing her income to help debt repayment.
The reality is there are many ways for someone such as Karen to get her debt situation under control and the same is true for you. Karen started by talking to an experienced financial planner and this is the best place to begin your quest for financial freedom.
The information provided is intended as a guide only and does not take into consideration your personal situation, needs and objectives and should not be considered as advice of any nature.