Getting control of debt.

I had a relatively new client approach me for help recently. This client and her husband have an unbelievable amount of debt. Her and her husband not only had a mortgage of $300k but they also had a personal loan for a new car of $25k and credit card debt totaling $120k (one for $80k and another for $40k).

This client came to me wanting advice on how to access some of her superannuation to stave off the creditors, albeit for a short time.

I managed to assist her with this request, however also I explained that with only $70k in superannuation continuing to do this would exhaust her superannuation really quickly. Leaving her and her husband over their heads in debt and no retirement savings.

There are a couple of reasons how my client and her husband got into this predicament. Firstly it would have been their decision to borrow to buy a house. This is a very normal thing to do. Fortunately for this couple they did not borrow beyond their means when buying their house. However somewhere between purchasing their house and now, my client and her husband got two new credit cards and ones with very high credit limits. Clearly the limits they had on the cards were too high and they quickly got caught in the credit trap.

The lure of credit is being able to buy what you want without have to front with cash then and there but at a later date (interest free within a certain time frame).

Consider this: if you didn't have a credit card and you wanted to buy something that was outside your regular budget you have one of two choices - 1. Save for the item or 2. Buy it now and sacrifice some of your regular budgeted items during this time. Either way this additional purchase has to fit within your existing cash flow or you simply can't afford it.

What my client and her husband had done (along with millions of other Australians) is get several credit cards and purchased the desired items now and continue to do this until the limit is reached and then make interest only payments from now on. They had also started to use their credit cards to afford themselves a better lifestyle. This extravagant lifestyle consisted of expensive dinners, nice clothes and fine wines. All to later come at a much greater cost. If you are buying an expensive bottle of wine that you could not normally afford in your cash flow, buying it on credit and then paying between 12% and 24% on top is madness. The enjoyment of the wine is short lived but the expense only gets greater the longer you take paying it off.

Essential items, such as a new fridge if your old one no longer works, are most likely not negotiable and purchases that have to be made.

The first thing that needs to be established is that once the fridge is purchased: will you be able to afford to pay off your credit card within the interest free period? If so the fridge has cost you exactly what the sticker price was. If not and you have to pay it off over a period of months then interest will be applied and the fridge cost you sticker price plus the interest payments on the borrowed sum until paid off. In order to pay off your credit card you MUST pay more than the minimum payment.

Here is a little secret the credit card providers know that they seldom share with credit card holders (you)… Let’s assume your new credit card has a limit of $3000 and you go out straight away and but a new fridge that costs exactly $3000 - Your entire credit limit. If you only ever pay the minimum repayment each month you will NEVER PAY OFF YOUR CREDIT CARD. If you don’t believe me call your bank and ask or search for a credit card calculator on the Internet and try it for yourself.  

Only once the credit card holder stops meeting their minimum payment / interest payment do the credit card providers start to take notice. Often the minimum is just the interest payment. The banks simply tell you what credit limit you can have not necessarily what limit you can afford. That part is up to you.

Getting control of your debt levels is the moral of the story here. If you find yourself with a maxed credit card and only paying the monthly interest, look to consolidate your debt. Talk to your bank about your options. Maybe transfer you credit balance to a personal loan or do a balance transfer to a credit card with a lower interest rate.

Most Important: stop using you credit card!!! Cut it up and do a budget. Work out what can cut from your existing expenditure and get your finances back on track. Get yourself in a position where you are paying off principle as well as interest. Then and only then will you begin to climb out of the credit honey trap.