First up, a confession. I only used that headline so I could use that picture. But Beyonce is full of good advice, which we shall get to later.
Truth is, many of us stumble through life with a trail of debt. Credit cards, university fees, car loans. Then we think about barrelling into more debt by buying a home .
However, I am not here to say ‘debt is bad’. It’s a normal part of life, and it can help boost your wealth when used appropriately.
But not all debt is created equal.
And whether it’s good or bad, debt costs us money. Nobody lends you money without the prospect of getting it back and making more on top.
Even that ’24 months interest free’ for your TV comes with monthly account fees. But what they really hope is that you will go over the 24 months and start paying 20% interest on the outstanding balance.
When the bank says ‘zero percent interest on balance transfers’ for your credit card, it really hopes you won’t pay it off before the special offer ends – and that you will, in fact, add more to it.
Let’s face it. The banks have you figured. If you need a balance transfer, you probably use your credit card a little too freely. Banks like you. They don’t like Nancy No-Spend, who pays her card off in full each month. She gives them nothing.
But debt can be useful when it helps you build wealth and magnify your gains. So let’s just spend a bit of time on the basics.
Why are some loans sooo expensive?
There are two types of people in this world: people who know how to walk, and people who are in my way.
That’s irrelevant, but I read it the other day and liked it. What I really mean is, there are two types of loans in this world – secured and unsecured.
In life, all risk is priced. Whether it’s the risk to a lender that you won’t repay a loan (hello 20% interest rate!) or the risk to an investor that they might lose money (hello cheap shares in speculative tech start-up!). So, it’s handy to remember that for all money conversations.
In terms of loans, secured is less risky to the lender. There is an asset – your home, a car or shares – that the lender can come in and take back if you don’t pay the loan. The risk for them is lower, and so is the interest rate.
Unsecured loans have none of this ‘collateral’ against them. When you don’t pay your credit card, the bank can’t come in and demand that you return all those bottles of Sauvignon Blanc you bought at Ryan’s Bar. Nor do they have any interest in your hot, over-the-knee boots from last season. (Losers, obvs).
Other than sending you mean letters from debt collectors, they can’t do much to get their money back. So this riskier loan is more exy – up to 20% interest or more.
So what’s a good debt?
Let’s call them ‘productive debts’. These loans can make you money – finance types call this ‘leveraging’. You borrow money to invest.
A home loan, in theory, will make you money because the value of your property grows.
Whether it balances out with the amount you pay in interest depends – on the interest rate, the property in question and a bunch of economic factors. In general, the more money you throw at the loan, the faster it gets paid off, the less interest you pay and the more money you make.
Similarly, you can take out a loan to buy investments – often shares – which magnify your gains. So instead of buying $100 of shares that make you $10 profit, you borrow another $100, invest $200 and make $20.
You end up paying back that hundred, plus interest, so you don’t entirely double your gains, but you certainly make more than just spending your own money.
These are called margin loans, and they can be a little tricky for the unwary. Say the shares you bought fall in value dramatically – from $10 each to $6. The bank gets worried because that’s not enough collateral to cover what you borrowed. So they make a ‘margin call’ – forcing you to sell down your shares or tip in more of your own cash.
Now I know that sounds a bit scary, and it can be; people lost a bunch of money this way during the GFC. But there are ways to manage the risk, by not borrowing too much in the first place.
To be honest, most of you probably aren’t going to dabble in margin lending, but if a spivvy financial adviser tries to sell you one, at least you know what they are talking about. (I was advised to get one right before the GFC, and didn’t. Dodged a bullet there).
And what’s bad debt?
Now we are friends with the good guys, let’s talk about the bad guys. Because that is always who I go for. Hello, Danny Zuko.
For simplicity, I will make a list of debts you should get out of your life as swiftly as Amber Heard kicked Johnny Depp to the curb and then donated her settlement to women’s charities (Fierce Girl for sure).
Credit Card Debt
Credit cards are useful if you have self-control. However, much like having a block of Cadbury Dairy Milk in the pantry, it doesn’t always end up they way you hope.
But rather than lecture you, let me share some of my failings in this area and offer some lessons.
Credit Card Disaster #1
When the NRMA demutualised back in 2001, they gave members shares in the company. I got a couple of thousands dollars worth.
I also had a couple of thousand dollars on my credit card from buying clothes and drinking at The Establishment (which was brand new and oh-so-cool). So I decided that I’d sell my shares and pay off the debt.
My dad said this was a rubbish idea, but what would he know?! I would clear my slate and go forth debt-free. On $30,000 a year!
So we can see how this ends. I liquidate my one asset with genuine growth prospects, settle a debt, then steadily rack it up again. Without meeting one decent guy at The Establishment. (Some things never change).
Credit card disaster #2
I came back from two years in London with nothing but memories, photos and one good pair of shoes. Luckily my dad and step-mum let me move in, and I got a decent job in PR.
What a great time to set myself up financially. I had been so poor in London, and now I had money! Hurrah!
Soooo, I spent it. All of it.
In fact, I splashed all my cash on God-knows-what and found myself in debt again. FFS.
Fast-forward a year or two, and with a better-paid job in Melbourne, I’d paid off the card and got back in control. Until…
Credit card disaster # 3 – My partner was working in hospitality when he had an accident and couldn’t work for months. So I became the breadwinner and we continued our lives as best we could.
Except we didn’t change our lifestyle, or our cost base. Maybe I trimmed at the edges, but essentially, we were still living like a two-income household. So we racked up debt again…
Ok, there is a pattern here, and if I am honest, it’s one I have never totally cracked. Currently at zero balance, but touch wood! [2020 edit – I have no credit card and no debt other than a mortgage – it is possible!]
The recurring theme is simply thoughtless spending. It’s one thing to have an unexpected costs come up, but another to just let your balance creep up incrementally because you’re a baller. Hence why I have tried to embrace mindful spending.
It comes down to the Micawber Principle. One of my fave Dickens characters, Mr Micawber is constantly in and out of debtors’ jail (yes, in Victorian England you got locked up for going bankrupt!). So he tells David Copperfield, over and again, “Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.”
If you don’t dig Dickens (*shakes head in disapproval*) then let me break it down for you: don’t spend more than you earn. It’s that simple … and that hard.
Fancy cars are for men with small … egos
A couple of years ago I told my brother how I was planning to buy a Toyota 86, a funky little sports car. He asked me a while later what happened to that plan.
“The flaw in my plan,” I told him “is that I forgot that I’m a massive tightarse”. So the 13-year-old Mazda 3 lives another day.
I don’t have much to say here except that cars are a depreciating asset (i.e. they lose money every day), they are mostly an ego decision, and they are a pain to pay for. Just buy the cheapest/safest car you can, and find your self-worth elsewhere.
Also, make sure you find a loan that you can pay out early – it shouldn’t take you five years to pay off a five-year loan. Throw extra money in and you will save on interest, as well as getting the monkey of debt off your back.
A HECS on your debt
If you are trying to choose which debts to pay off first, leave this one down the list (other than the minimum of course). It’s pretty much interest free (they index it, but don’t charge interest), so just let that one tick over on the government’s balance sheet for as long as possible.
If you have concurrent debts, such as HECS, a credit card and a car loan, look at which one is charging the highest interest and smash that one first.
It will require patience and dedication and sacrifice, but so does pretty much everything worth doing.
Be like Beyonce! Work hard and grind hard til you own it (life, that is).