How to avoid getting further into debt and get spending habits back in line.

Apr 27, 2020

Welcome to Finance and Fury. Credit cards and pay day lenders are on the rise, as some of those out of work are becoming strapped for cash. Today, we look at this further but also look at some alternative strategies to avoid the debt traps. We’ll also look at how to use this as a chance to get spending habits back in line.

First – situations to avoid getting further into debt

1. High interest loans are being offered to people via text messages - offering short-term loans to get them through whilst they are unable to work
   1. Known as pay day lending – but also offering short-term high-interest loans
   2. Obvious issue with this is that these loans trap vulnerable people in a debt cycle that is difficult to escape
2. No doubt – a lot of the population is going to suffer financial stress –
   1. The National Debt Helpline says almost 10,000 people have called for help during the past month, but demand is so high that some calls are not getting through.
   2. "A lot of people who are calling us are incredibly stressed and really worried about how they're going to put food on the table," said Katherine Temple from CALC, which helps to staff the helpline.
   3. Callers' problems include credit card debt, trouble paying personal loans, mortgage arrears and other household debt.
   4. Welfare organisation Good Shepherd, which administers a scheme offering no-interest loans of up to $1,500 to people on welfare, says it has seen a significant increase in enquiries from people who have never needed emergency financial help before.
3. They sound enticing – you are out of money and you get messages offering the promise of quick finance with limited requirements – just click the link and get the money you need now – Up to $30k paid within the hour

 

What are these loans and how do they operate -

4. Small Loan - Loan Amounts: Minimum $200 to Maximum $2,000
   1. Terms: Minimum 16 weeks to Maximum 50 weeks
   2. Costs: Up to 20% Establishment Fee charged upfront plus a monthly fee up to 4% based on a maximum Annual Percentage Rate (APR) of 98%
   3. Example: Loan Amount of $1,250 over 28 weeks repayable weekly - $1,250 (Principle Amount)+ $250 (20% Establishment Fee) + $350 (fees based on APR of 98%) = $1,850 total repayable in 28 weekly instalments of $66.07 - $154 p.m.
5. Medium Loan - Loan Amounts: Minimum $2,005 to Maximum $3,000
   1. Terms: Minimum 39 weeks to Maximum 52 weeks
   2. Costs: $400 Establishment Fee plus fees based on a maximum Annual Percentage Rate (APR) of 48%
   3. Example: Loan Amount of $2,500 over 52 weeks repayable weekly - $2,500 (Principle Amount)+ $400 (Establishment Fee) + $760 (fees based on APR of 48%) = $3,660 total repayable in 52 weekly instalments of $70.38 - $305 p.m.
6. These loans result in additional costs having to be covered for funds today – at a more expensive rate than what those if they are already in financial trouble can afford
7. They have come under legislation in the past few years - Last year, one payday lender became the first target of the ASIC new product intervention power, after it charged repayment rates of up to 1,000% via various fees – such as missed repayments
8. To avoid this – some people are putting additional expenses on their Credit Cards – racking up an additional bill for this as well to be paid back in the future -
   1. If people were already in debt, would be getting further into it

 

Debt collectors and bankruptcy

1. If a debt collector is chasing you for money, you do have some legal protections under consumer laws.
2. Amid fears that large numbers of people could be declared bankrupt over unpaid debts due to shutdowns, the Government has temporarily relaxed some of the rules in this area.
3. It has changed bankruptcy laws so that creditors cannot apply for bankruptcy over amounts of less than $20,000.
   25. The new rules apply for a period of six months from March 25.
4. People who owe money will have up to six months to respond to a bankruptcy notice before bankruptcy proceedings can take place.

 

What other Financial options are available during COVID-19

1. Australian banks are offering some customers the option of deferring mortgage repayments for up to six months, as well as forgiving fees and restructuring other types of loans.
2. At the same time, people in financial crisis can access up to $10,000 of their superannuation savings before July 1, and a further $10,000 after that date.

 

Other option – If you don’t need to do it – don’t take money out of super – i.e. you aren’t in debt or are struggling for income

1. But say you do need spending – then you can use it – instead of pay day lending – but then SS back to super
   1. Avoid the massive upfront costs – high interest rates and also save tax on the repayments
2. Or – One of my friends had some CC debt – met the requirements but got a new position
3. Made me think of a strategy for their situation - Use super access as eligible as they were made redundant before getting a new position – then pay off CC debt – But – only if he was going to SS the funds back

 

General illustration only – might not work for you

1. Example - $10k on CC debt – paying 18% of interest each year – and having trouble paying this off –
   1. If you wanted to pay this off in 12 months – would be about $940 p.m.
   2. If you are on say $70k p.a. – net income PM is about $4,615 – so would leave you with $3,675 p.m. after repayment –
2. Option - Withdraw super – $10k – if you meet the requirements – and then SS the money back in to super over 12m
   1. SS $11,764 - $10k net after 15% - replace the money
   2. Net result – save yourself about $1,244 in interest payments – save yourself about $4,083 in tax personally -
      1. Still have to pay 15% tax to super – so net tax about $2,800
   3. Net income would be $300pm more than trying to repay the CC loan personally
3. Obviously the returns for super cant be forecasted – but as long as the funds can be SS back in soon – market rebounds can help to be avoided to be missed

 

This can be a time to re-address spending - and get out of debt – but making sure you don’t get back into debt - What are the elements that help?

1. Regaining control – Finances shouldn’t control you –
   1. Having control/certainty reduces stress – Knowing what you are in for helps, but being able to control it works better
   2. Tail wagging the dog – Financially stressed people spend to feel better
      1. Have $10k in CC debt, so spend $300 on a night out to make it better – spending gives control
   3. But you can get control over the debt – forming good habits and increase certainty
2. What you can do - Endowment effect – Put more value to what you already own
   1. Turn it into thinking about Keeping your money – put a premium on your spending habits
      1. Essentials – 0% - no need to put a FV on this – unless you think a porche is an essential
      2. Non-essentials – Gross the price up by a factor:
         1. Example - New TV is $3,000 – Life of TV is 10 years –
         2. Earn 7% on that over the same time - Is the TV worth $6,000?
      3. Opportunity cost - To part with your money - the item better be worth it
      4. Have to change habits though - Ways to solve – Break Three timeframes to focus on

 

Now, medium and longer terms – Build the basics now

1. Short term – What you can do right now – Gaining control
   1. Get disciplined – Stress comes from the unknown – Jocko says – Discipline equals freedom
      1. budget – Get to know what you are spending, and when you are spending it
      2. Set aside money to cover this – Aim to have your own left over as well
   2. Pay yourself first – Getting out of debt first – then building wealth for your future –
      1. Direct debits – Once you know your costs and incomes, you can pre-plan – set and forget to remove the stress
      2. Get apps to track it for you
   3. Very simple to do – can be a harsh reality – ‘hard truth’ – if your income has gone down and your spending was meeting your income – can be a good chance to lower the hedonic treadmill – unpleasant but would be beneficial long term
   4. Example - Once you are covering your bills with ease – Managing to get ahead – Ready for next stage
2. Medium term – Once you are feeling less stressed – In control you can plan for the future
   1. Start planning – Saving targets to be achieved need longer term planning
   2. You need to have covered the basics before moving on to stage two
   3. Examples – Wants: Holidays, new cars, home deposits
3. Long term
   1. Start Investing – Long term goals normally include having debt paid off or generating a passive income
   2. Long term goal of reducing financial stress for your future.
4. All three are important
   1. The long term will become the short term if you aren’t careful
   2. Short term - Stress occurring now – Meeting the bills day to day (ultimate stress and priority)
   3. Stress that will occur in a few years – May not be at the front of mind, but when it comes time that you need a new car
   4. Stress that will occur at retirement – One of the long-term consequences of not planning is having stress for the rest of your life financially
   5. Get to 65 – Don’t have enough to live off – Well you are back to the short term – day to day trying to get by
   6. Might have a nice car, or house with a lot of debt – but you will need to work until you are 80

 

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