Australians have a complex relationship with debt. In 2014, RateCity found that 42% of young people under the age of 24 have between $10,000 and $30,000 of personal debt, not including a mortgage. More than half (56%) of Generation Y’s with a credit card were found to have never had a $0 balance on their credit card in the previous year, and 63% were not aware what interest rate they were paying.
While a certain amount of debt can prove useful for enjoying convenient access to goods and services you otherwise couldn’t afford (at least not without making a concerted long-term effort to save money), it’s all too easy for debt to get seriously out of hand. What’s worse, through no fault of your own, you may not even realise you’re in trouble until it’s too late.
Here are a few signs of a potential debt problem to watch out for:
More than 20% of your spending money goes towards loan and credit card payments
Even if you haven’t prepared a formal budget, you can quickly find your disposable income by deducting your living expenses such as rent and mortgage repayments from your regular pay. If a significant percentage of this remaining cash is going straight onto the credit card to cover your previous expenses, it could be a sign of a debt problem.
Making minimum payments only
It makes sense to try and pay off your credit card debt as quickly as possible, especially if you can do so during your card’s interest-free period. However, when your finances are tight, it’s all too tempting to instead make repayments for the minimum possible amount, and keep your monthly budget more affordable in the short term.
Unfortunately, this can risk leaving you in a position not unlike the Red Queen in Alice Through The Looking Glass:
Because the minimum required repayment for most credit cards is typically quite low (often just 2% plus any interest owing, depending on the lender), you won’t make much of a dent in the debt you owe by sticking to the minimum repayments, which in turn means you’ll be charged more interest on the remaining balance.
If you can only afford to make these minimum repayments, the time it’ll take to pay off even a small debt could be extended by years, and cost you much more in interest charges. If you add to what you owe by making additional credit card purchases, you could end up undoing any previous progress made towards clearing your debt, or even end up in a worse place than when you started, leaving you trapped in a cycle of debt!
It’s a similar situation for home loans and personal loans that offer the option to switch to interest-only repayments for a limited period. While this can reduce your financial pressure in the short term, you won’t be reducing the amount you owe during the interest-only period, so your loan will ultimately take longer to pay off and cost you more in total interest. And if it looks like you’ll be unable to afford the repayments when the loan’s interest-only period expires, it may be time to contact your lender.
Being declined credit
While having your credit card declined at the supermarket obviously isn’t a great sign, that’s not what we’re referring to here. Instead, we’re talking about having your application for a new loan or credit card rejected by a lender.
When lenders are deciding whether or not to approve your application for a loan or credit card, they not only check your credit history for defaults and bankruptcies, but also look at your existing level of debt and the number of recent credit applications you’ve made. Even if you have a clean credit history in terms of having never missed a repayment, a lender could still turn down your credit application if they feel that your existing level of debt is too great for them to responsibly lend you any more money.
Cases like this can serve as an indicator that you may be burdened with too much debt at present, and that you may want to look into your options for reducing what you owe before looking into any additional loans.
Borrowing money to pay debts
The traditional expression “robbing Peter to pay Paul” could be modernised into something like “maxing out my Peter Bank Credit Card to pay the interest on my Paul Financial personal loan”.
Borrowing money from one loan to pay for a second loan could potentially leave you in twice as much trouble, where you may be out of the woods in the short term, but you’ve put yourself into more debt, with more interest to pay in the longer term.
Similar principles apply when borrowing money from friends and family to pay off your debts to banks and other lenders. While loved ones may offer you their heartfelt support with the best of intentions, if you’re finding yourself relying wholly on the assistance of your social circle to keep your finances afloat, that could be a sign of a debt problem.
Note that this isn’t the same as taking out a debt consolidation loan, which is intended to replace your existing unmanageable debts by refinancing them into a single manageable personal loan, or even your mortgage, rather than offering a quick fix. Depending on your financial situation, by sticking to the repayment plan of a debt consolidation loan, you can keep your budget simple, and slowly but surely bring your finances back under control.
There’s also the option of a credit card balance transfer available, which is similar to refinancing a home loan, but for credit cards. In this arrangement, you’ll take out a new credit card from another lender, transferring the balance you currently owe onto the new card. Often, the new lender will charge no interest on the transferred balance for a limited period of time, offering you the ideal opportunity to start quickly paying off the debt! However, once this interest-free period expires, you’ll likely be charged interest at a high rate on any leftover balance. And depending on the lender, if you make any new purchases with this card, you may immediately be charged interest at the high revert rate, even during the interest-free period for the transferred balance.
It’s happened to the best of us – we’ve all copped an overdue library fine, or left a phone bill sitting unopened and forgotten on the coffee table until it’s too late. But these are (relatively) small potatoes compared to missing payments on credit cards, personal loans and mortgages, which can have an immediate and nasty effect on your credit history (though you should still pay those phone bills – they can also end up on your credit history if left unpaid!).
If you don’t have enough funds available in your account to cover your loan or credit card repayments when they fall due, rather than letting the due date pass, crossing your fingers and hoping to make up the costs next month, you should contact your lender as soon as possible and start discussing your options.
Debt collectors are chasing you
Debt collectors aren’t the scary hired goons you see in the movies. In fact, debt collectors are obliged to treat you politely, and forbidden to harass, coerce or deceive you. And rather than appearing unexpectedly on your doorstep, debt collectors are more likely to contact you by phone to discuss your debt. They may also write you letters or reach out to you online, and only seek you out in person if they have trouble contacting you through other channels.
If your debts have gone unpaid for long enough that your lender is chasing you up with debt collectors (whether from their own staff or from a debt collection agency), you could be in some serious financial trouble. Talk to the debt collector and/or your lender to work out your options, so you can determine the best course of action going forward.
How to get financial help:
If you’re struggling with financial hardship, you can find financial guidance and advice at the Australian Securities and Investments Commission’s (ASIC’s) MoneySmart website.