Facing cash flow issues and falling behind on repayments because of COVID-19? There are ways to manage debt during a crisis to help stay financially secure for the future.
We do not need to tell you these are challenging times. The Federal Government estimates that around 6 million workers1 will receive financial assistance in the coming months, having lost all or part of their income due to the coronavirus pandemic.
Whether you are a full-time employee experiencing a loss of income, a casual whose hours have been cut, or you’re a small-business owner now struggling to pay your bills, you’re not alone in facing and managing debt. Approximately 74% of Aussie households held an average debt of $168,6002 in 2015-16. Of this, credit cards are the most common form of debt, held by 55% of households, followed by home loans (34%) and student loans (17%).
At times of financial hardship like these, it can be all too easy to get further into debt without examining all your options. Some factors to consider include which debts are costing you the most money, which will have the greatest impact on your financial future, and which will free up some much-needed cash. So, before you pull out your credit card to ease the pressure, here are a few things to ask yourself when you are managing debt.
Can any of my repayments be paused?
When cash is tight, you may wonder how you will continue to repay any outstanding amounts – especially if you have multiple debts. However, it may be possible to temporarily pause or defer certain payments to help you get through the next few months.
Many Australian banks3 are offering mortgage relief on home loans by “freezing” repayments for up to six months, potentially freeing up cash flow. Newcastle Permanent has taken a hands-on approach with their clients. For more, visit their website here. Do your research before taking this path – some banks may impose interest capitalisation on all freezes, meaning interest still accumulates and must be paid off when you “unfreeze” your loan.
On top of this, many banks are currently offering relief on credit card repayments, from deferring debt repayments to cutting interest rates4. Speak to your lender as soon as you can to work out what options are available to you.
Which debt should I pay off first?
If you are juggling multiple debts it can be hard to know where to start with your repayments. There are some rules of thumb that can help you work out which debts to prioritise. Let us say you have four debts:
$2,000 on a credit card, which charges 19% interest and has a $9,000 credit limit
$336,500 home loan (the Aussie average for first home buyers5), with an interest rate of 3% and no redraw available
$10,000 on another credit card, which charges 24% interest and has a $15,000 credit limit
$7,000 personal loan at 7.5% interest
Generally, it makes good financial sense to pay off debts in order of interest rate charged, from highest to lowest. So, in this example you would pay off debt 3, 1, 4 then 2. The thinking behind this is that mathematically, this will lead to the lowest dollars-and-cents repayments in the long run.
If you have one smaller debt you might also consider paying this off first, followed by your other debts in order of highest interest rates. In this example that means paying off the $2,000 credit card (debt 1) first, followed by the debts 3, 4 and 2.
Independent of other considerations, the theory here is that you will likely pay off the small debt faster, get a psychological boost from doing so, and want the empowerment of seeing all your debts paid off. Once you have paid off all of your debts, and are looking to move forward, visit Newcastle Permanent for a range of home loan deals.
Should I consolidate my debts?
Debt consolidation means rolling all your debts into one new single debt.
The pros: it can equate to lower (and easier to manage) repayments and give you a clearer picture of your financial future. Let us say you take out an unsecured personal loan to consolidate your high-interest debts, like credit card balances. You no longer must juggle multiple repayments, and they will also likely be reduced thanks to typically lower interest rates on a personal loan compared to on a credit card.
The cons? It can potentially affect your credit score and turn short-term debt into long-term debt. For example, your home loan interest rates are likely to be much lower than your credit cards. However, if you were to increase your mortgage to pay off these high-interest debts, it can turn short-term debts (credit cards, personal loans) into a much longer-term debt (your mortgage), meaning you could end up paying more interest over the life of the loan. If you consolidate your debts in this way ideally you will want to maintain the previous level of overall repayments, so the interest cost does not blow out over the longer term.
Are ‘payday loans’ worth considering?
When you need cash fast, payday loans might seem like the ideal quick fix. These small loans – usually around $2,000 but in some instances up to $10,000 – are popular for many reasons: they’re short-term, there are no restrictions on what you can use them for, they can be approved in a matter of minutes online and the money can be quickly transferred to your account. On the surface, they are so appealing that Aussie households took out more than 4.7 million individual payday loans between April 2016 and July 2019, worth approximately $3.09 billion6. However, there is a flipside.
These loans can come with very high fees attached to them, which means you could find yourself in a debt spiral in a very short space of time. Borrow less than $2,000 and you are generally faced with an establishment fee of up to 20% of your loan, as well as monthly account fees. Borrow between $2,000 and $5,000 and you could pay a $400 establishment fee and up to 48% annual interest. Borrow more than $5,000 and pay up to 48% annual interest.7 Compare this to average credit card interest rates, which are around 20% (some with additional annual fees).8
Should I worry about my credit score?
Think of your credit score as an overall picture of your financial health, taking into consideration things like how much debt you are in, whether you pay interest on time and how many credit applications you have made.
While your finances might seem overwhelming right now, it is a good idea to keep your financial future in mind. When we get through this, let us say you want to take out an additional loan to boost your business, purchase property or go on a dream holiday. If your credit rating is low – which is to say, lenders consider you risky – then you may find it tricky to borrow money.
What types of financial assistance may be available?
There has been a loud – and consistent – mantra across Australia in recent weeks: You are not alone. In addition to banks offering home loan relief, the government has announced a range of measures to support individuals and businesses affected by COVID-19 (coronavirus). These range from JobKeeper payments, to household stimulus packages and financial support for retirees.
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