If debt is keeping you up at night, you’re not alone. Lots of us are worried about how much debt we have and how we are going to pay it off. According to the ABC’s 2019 survey, Australia Talks, 90 percent of the 55,000 people who responded said debt was a problem for them — and with Deakin University identifying that financial control is part of the “golden triangle of happiness”, it’s clearly an issue that’s affecting our wellbeing.
The good news is — with the Reserve Bank of Australia’s cash rate now sitting at a historic low — there’s never been a better time to pay off your debts. Becoming debt-free isn’t always easy, but thankfully there are some strategies you can put in place to get you out of debt sooner.
Iona, 24, is typical of many young women her age when it comes to debt. “I love shopping — okay, I’ll admit, I was a totally addicted to Afterpay!” she says. Having just entered the workforce after finishing university, she’d racked up thousands in consumer debt, including credit cards, shop-now pay-later schemes, and a car loan. Her approach to getting rid of it? A debt detox.
“I was drowning in payments and couldn’t edge forward — every time I managed to pay something off, I’d find myself building my debt right up again.”
Iona’s first action was to list her loans on paper, a process that proved to be a shock to the system. “I realised the car payments were killing me, so I made the very painful decision to sell my car. I simply couldn’t afford it.”
With a large chunk of money now freed up each month, Iona drew up a budget to work out where she could allocate funds to the debt. She also structured her bank accounts to align with her daily expenses — and any money that was left over at the end of each pay cycle went straight to paying off debt. “It was hard, but as I started to see progress, I became ruthless.”
Iona’s biggest tip to people looking to get out of debt? “Stop thinking about it. Just jump in, start small if you have to, and sell some stuff to get quick wins on the board. You’ll feel so much better when you don’t owe anyone any money. It’s like a work-out — worth the pain.”
Not everyone will be as gung-ho as Iona in eliminating their debt, but if you do decide to take stock of your financial situation, these strategies might help you to get on top of your obligations.
One approach getting debt-free is to pay off the debt with the highest interest rate first, regardless of the size of the balance. You then move on to the debt with the next-highest interest rate — and then follow this process until you reach the debt with the lowest interest rate. Often referred to as the “debt avalanche” method, this approach seeks to minimise the amount of interest you pay, which might mean you pay off your debts quicker.
This approach typically starts with your credit cards, followed by personal loans — but remember to keep making the minimum payments on all your debts, so you don’t get hit with late-payment fees.
Paying down the plastic
Credit cards can be an extremely useful tool, especially if you can pay off the balance in full each month. But it’s important to manage them properly, as debt can quickly balloon.
“For most people, it’s a good idea to pay off your credit cards first, as this debt usually has the highest interest rate,” says Australian Unity’s Senior Financial Adviser, Elise Michelmore.
If you have multiple credit cards, consider focusing on the card with the highest rate first, as this can save you the most money on interest. Once that’s paid off, tackle the card with the next-highest interest rate, and so on.
Another option is to transfer the balance of high-interest rate cards to a zero- or low-rate card and pay down as much of the balance as you can before the no-interest or low-rate period ends. Do check the interest rate of the card you’re switching to, though —once the introductory-rate period ends, you don’t want to end up paying a higher rate than before.
Managing personal loans
After credit cards, car loans and personal unsecured loans often attract the next-highest interest rates. So once you have your credit card under control, it’s time to get a handle on these borrowings.
Says Elise: “These are debts that are not creating value. Let’s take a car loan: a car is certainly a useful asset, because it gives people a means to get to work and go about their lives. But it's also a depreciating asset, especially for vehicles that are only used for personal reasons. A car used for business purposes can be depreciated for tax purposes and its costs can be claimed as a tax deduction. But this is not the case for cars used only for personal reasons.”
If you do need a loan, actively plan ahead to make it easier to pay off the debt. “Look for a car loan with the cheapest interest rate you can find and try to pay off as much as possible during its depreciating life,” Elise says. “This means you’ll only have a small balloon or no residual value at the end of the lease term.”
Debt consolidation is another way to substantially reduce the amount of interest you pay on your debts.
Using this strategy, borrowers take out a personal loan and transfer higher-interest debts, such as credit cards , to this lower-rate loan. The benefit is that you only have one loan to manage, which can take the stress out of juggling multiple debts with various interest rates.
Let’s take a look at how much interest you could save if you consolidated your credit cards into a personal loan. According to Canstar research, released in April 2020, the highest credit card rate has an interest rate of 24.98 percent. But the average rate for a personal loan is just 10.30 percent, saving you substantial interest and potentially hundreds or thousands of dollars over time, depending on your debt.
As with the debt avalanche method, minimising your interest means you can funnel more money into paying off the debt itself — which potentially means you can pay off your debts sooner.
A tried-and-true way to fight debt is the “debt snowball” method, where debts are paid off from smallest to largest, regardless of the interest fees.
To work this strategy, you continue to make the minimum payments on all your debts, but any other cash you can find — left over from your grocery budget, or from a side hustle or eBay sale — gets thrown towards the smallest debt. Once you knock that out, you use the payment you were putting on the smallest debt to the next debt on the list, and so on up the chain, until your debts are paid in full.
The beauty of this method is that you can quickly gain momentum — seeing those smaller debts get paid off quickly helps motivates you towards the larger ones.
If you’re worrying about your HECS debt, the short answer is: don’t. Your HECS repayments are based on your income, which means your ability to afford the payments is taken into consideration. What’s more, your HECS debt is effectively interest-free. However, indexation is added to your debt on 1 June each year.
So, while you can certainly make voluntary repayments, consider tackling other debts —like your credit card — first.
The right debt-reduction strategy depends on your individual circumstances, how much debt you have and how keen you are to get rid of it. But whichever strategy you choose, the important thing is that you’re getting rid of those debts, one by one, and reducing your stress as you go.