Good debt and bad debt, how to consolidate and save

Good debt and bad debt, how to consolidate and save

Even if you didn’t pay much attention to the 2017 federal budget, you may remember how it was presented a little differently. Rather than focusing solely on surpluses versus deficits, the federal government sorted its borrowing into “good debt” and “bad debt”.

As Federal Treasurer Scott Morrison explained to a sceptical audience in the lead-up to the 2017 budget, good debt involves borrowing money to pay for an asset that’s going to add value or provide future benefits, whereas bad debt involves borrowing money to cover the cost of something that won’t provide the same kind of long-term value.

These principles not only apply to federal budgets, but to everyday household budgets as well. Here’s how to determine what good and bad debts you owe, and how you can use your good debts to help you manage any bad debts:

Good household debt

It’s true (from a certain point of view) that debt isn’t automatically a bad thing. A reasonable level of well-managed debt can allow Australians to enjoy lifestyle benefits and luxuries, or make progress towards goals that they’d never otherwise be able to achieve.

Generally, any debt that helps you to build more wealth in the long term, or otherwise puts you in a better lifestyle position, can be counted as a good debt under the right circumstances.

Home loans are often considered to be good debts. Yes, buying property involves borrowing a sometimes staggering amount of money, and can make a major impact on any household budget. But a home loan also makes the borrower the owner of a property that can serve as a roof over their head and/or an asset that can provide financial returns and potentially increase in value over time.

Other examples of good debt can include (under the right circumstances):

  • loans to finance investment in shares that can increase in value
  • loans to pay for education that can help you get a better (and/or higher-paying) job
  • loans to start a business whose revenue may one day pay for itself

Bad household debt

Bad debt is borrowed money that doesn’t provide additional financial benefits over time. At best, bad debts take a long time to pay off, and cost you more than the value of any benefits they once provided. At worst, they’re debts where interest, fees and other charges keep growing faster than you can pay them off, turning your otherwise innocuous loan into an inescapable spiral of increasing debt.

The go-to example of bad debt – as used by the Federal Treasurer – is a credit card. While credit cards play an important role in helping Australians to manage their everyday expenses, if used irresponsibly or mismanaged, they can quickly get out of control. Most credit cards require very low minimum repayments, so it can be very tempting to run up big spending debts and put off paying them back until later. Because the interest rates on credit cards tend to be on the higher side, these debts can quickly grow to be much higher than you can realistically afford to repay.

Of course, credit cards aren’t the only source of bad debt. Just about any loan can turn into a bad debt if it’s left unpaid, as the interest, fees and charges can lead to it growing to the point where you just can’t afford to keep up with your repayments.

Car loans are sometimes treated as bad debts, as unlike properties, vehicles generally depreciate in value over time, meaning you’ll more than likely end up paying much more towards a car loan than your car is ultimately worth. On the other hand, owning a car can provide significant lifestyle benefits, and if you use your car for work, it can help contribute to your overall financial well-being. Remember to carefully consider your financial situation before applying for a car loan.

How to consolidate your bad debt with your good debt and save

The simplest way to get rid of bad debt is to just pay it back, though this is rarely as easy as it sounds. If paying your debt back isn’t realistic or affordable, then another option that may be worth considering is consolidating your debts. It’s possible to do this by taking out a specialised personal loan, but another reasonable option is to refinance your existing home loan.

Refinancing a home loan is often undertaken to take advantage of a cheaper interest rate.  This reduces the loan’s minimum repayments, so borrowers can enjoy greater affordability from month to month, or pay the loan back faster and save on interest in the long term.

An alternative option when refinancing a home loan is to borrow some more money, and use it to pay off other outstanding bad debts, such as maxed out credit cards or overdue car loans. This may sound at first sound like simply swapping one type of debt out for another, but there are a few benefits to consolidating your debts, including:

  • Simpler budgeting – Rather than juggling multiple repayments for the home loan, the car loan, and each of the credit cards, you can just make the one repayment each month.
  • One interest charge – When you’re paying off multiple debts to multiple lenders each month, you’re also paying multiple interest charges. By consolidating your debts into one loan, you’ll only need to make one interest payment each month, no matter how many old debts you’ve rolled into the loan.
  • More affordable repayments – Home loan interest rates are generally lower than credit card or personal loan interest rates. When you’re only being charged interest the once at this lower rate, your monthly repayment will likely be lower than the previous combined cost of covering your various other bad debts.

What to watch out for when consolidating bad debt

One of the most important things to remember when thinking about consolidating debt is that once you’ve paid off your bad debts, don’t let them come back! If your credit card was causing you financial problems, once you’ve consolidated its debts it’s worth thinking seriously about cancelling the card rather than risking building up an all-new debt that could run out of control all over again.

Another important consideration when consolidating debt is that you likely won’t end up saving money in the long term. While your monthly repayments will likely be more affordable than paying off your bad debts separately, when you consider the longer terms of most home loans, you’ll likely be making a greater number of payments on your debt, and thus pay a higher amount of total interest, even at the lower rate, than you likely would if you pay off your smaller bad debts separately.

Consider this example (totals and interest rates are examples only and not indicative of current market rates):

BEFORE DEBT CONSOLIDATION:

Type of loan Loan amount Interest rate Loan period Monthly repayments Total interest Total cost of loan
Home loan $600,000 5% 30 years $3221 $559,535 $1,159,535
Personal loan $10,000 9% 3 years $318 $1448 $11,448
Car loan $30,000 9% 5 years $623 $7,365 $37,365
TOTALS $640,000     $4162 $568,348 $1,208,348

AFTER DEBT CONSOLIDATION

Type of loan Loan amount Interest rate Loan period Monthly repayments Total interest Total cost of loan
Home loan (refinanced with debt consolidation) $640,000 5% 30 years $3436 $596,836 $1,236,836
TOTAL SAVINGS       $726 -$28,488 -$28,488

Remember: if you’re in financial hardship and struggling with bad debt, you should always carefully consider your available options and do your calculations so you can be confident that you’re making an appropriate financial decision. If you’re uncertain, seek independent financial advice, or contact the ASIC debt helpline.

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Can I get a home loan if I owe taxes?

Owing money to the Australian Tax Office is not an ideal situation, but it doesn’t mean you cannot qualify for a home loan. Lenders will take into account your tax debt, your history of repaying the debt and your other financial circumstances, while reviewing your home loan application. 

While some banks may not look favourably upon your debt to the ATO, some non-bank lenders may be willing to help. They will look into the reasons for your tax debt and also take into account the steps you have taken to repay it before deciding whether to offer you the loan or not. Having said that, there are no guarantees - it depends on your whole financial picture.

Here are a few steps that you can take to improve your chances of getting approved for a home loan.

  • Demonstrate evidence of income.
  • Manage your debt by paying it off in installments.
  • Offer an explanation for your tax debt and a plan to pay it off.
  • Do what you can to stay out of court or attract debt collection agencies.

 

What is the average length of a home loan?

Most Aussie lenders offer home loans with a 30-year term, meaning that you should pay back the full loan amount and the interest you owe on the amount in 30 years. 

However, home loans can also have a shorter or longer term. They may be as low as ten years or up to 45 years, depending on the product and lender. 

It’s worth remembering that a longer loan term usually means you’ll end up paying a lot more interest in total, but your scheduled repayments may be more manageable. In contrast, you could opt for a shorter loan term if you are comfortable making large repayments in exchange for paying less interest over the term of the loan.

How do I get a pre-approved home loan with Aussie?

Getting Aussie home loan pre-approval means receiving conditional support from Aussie Home Loans to borrow the money you need to buy a home. 

It’s an indication of the approximate amount Aussie may offer you, subject to some terms and conditions. Keep in mind, having a pre-approved home loan does not guarantee an actual approval of your loan when it comes time to buy.

Aussie home loan pre-approval often involves speaking to one of the lender’s brokers. You can make an appointment online. You’ll often have to submit your personal details and other information about your assets, income, liabilities and expenses.  It’s worth remembering that a pre-approved loan is usually valid for a few months.

Can I get a NAB home loan on casual employment?

While many lenders consider casual employees as high-risk borrowers because of their fluctuating incomes, there are a few specialist lenders, such as NAB, which may provide home loans to individuals employed on a casual basis. A NAB home loan for casual employment is essentially a low doc home loan specifically designed to help casually employed individuals who may be unable to provide standard financial documents. However, since such loans are deemed high risk compared to regular home loans, you could be charged higher rates and receive lower maximum LVRs (Loan to Value Ratio, which is the loan amount you can borrow against the value of the property).

While applying for a home loan as a casual employee, you will likely be asked to demonstrate that you've been working steadily and might need to provide group certificates for the last two years. It is at the lender’s discretion to pick either of the two group certificates and consider that to be your income. If you’ve not had the same job for several years, providing proof of income could be a bit of a challenge for you. In this scenario, some lenders may rely on your year to date (YTD) income, and instead calculate your yearly income from that.

How long does Bankwest take to approve home loans?

Full approval for a home loan usually involves a property valuation, which, Bankwest suggests, can take “a week or two”. As a result, getting your home loan approved may take longer. However, you may get full approval within this time if you applied for and received conditional approval, sometimes called a pre-approval, from Bankwest before finalising the home you want to buy.  

Another way of speeding up approvals can be by completing, signing, and submitting your home loan application digitally. Essentially, you give the bank or your mortgage broker a copy of your home’s sale contract and then complete the rest of the steps online. Bankwest has claimed this cuts the approval time to less than four days, although this may only happen if your income and credit history can be verified easily, or if your home’s valuation doesn’t take time.

What are the NAB term deposit interest rates for businesses?

If you’re looking to lock in a return on your business savings, one option is a business term deposit with NAB. The big four bank provides competitive interest rates while giving you the flexibility to choose the term. NAB offers business term deposit interest rates for investments of between $5,000 to $499,999.

NAB doesn’t charge any monthly account or application fees. The interest is calculated daily and for the 90-day term and six months term, you will get paid when the deposit matures. For the 12 months term, you can either choose to get paid monthly, quarterly, half-yearly or annually. 

If you wish to withdraw your funds before the deposit matures, you need to give NAB 31 days notice. However, they do make exceptions if you’re experiencing hardship and need the funds immediately. Either way, you may have to bear the prepayment cost, which you can learn more about in the Terms and Conditions.

Does Westpac offer loan maternity leave options?

Having a baby or planning for one can bring about a lot of changes in your life, including to the hip pocket. You may need to re-do the budget to make sure you can afford the upcoming expenses, especially if one partner is taking parental leave to look after the little one. 

Some families find it difficult to meet their home loan repayment obligations during this period. Flexible options, such as the Westpac home loan maternity leave offerings, have been put together to help reduce the pressure of repayments during parental leave.

Westpac offers a couple of choices, depending on your circumstances:

  • Parental Leave Mortgage Repayment Reduction: You could get your home loan repayments reduced for up to 12 months for home loans with a term longer than a year. 
  • Mortgage Repayment Pause: You can pause repayments while on maternity leave, provided you’ve made additional repayments earlier.

When applying for a home loan while pregnant, Westpac has said it will recognise paid maternity leave and back-to-work salaries. All you need is a letter from your employer verifying your return-to-work date and the nature of your employment. Your partner’s income, government entitlements, savings and investments will may help your application.

How do I get a Suncorp home loan pre-approval?

Getting home loan pre-approval helps you work out a budget to help you search for a suitable property and make an offer with confidence. Once you put in an application, you should get your pre-approval outcome within two business days. To help get a fast turnaround time of your pre-approval application, ensure all the information and documentation that Suncorp requires. This includes proof of identification, recent payslips, bank account and credit card statements.

You can submit the home loan pre-approval application online. You’ll be asked for information about your income, expenses, assets, and debts. It should take you about 10 minutes to fill out the application, and you can do it free of charge. A Suncorp lending specialist will review your application and contact you within 24 hours or the next working day. Suncorp will not run a credit check until you have heard from this lending specialist.

Once you get Suncorp home loan pre-approval, it’s valid for 90 days. If you don’t find a property you wish to buy in this time you may be able to apply for an extension, speak to your Suncorp lending specialist about this.

What is an interest-only loan? How do I work out interest-only loan repayments?

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

Can I take a personal loan after a home loan?

Are you struggling to pay the deposit for your dream home? A personal loan can help you pay the deposit. The question that may arise in your mind is can I take a home loan after a personal loan, or can you take a personal loan at the same time as a home loan, as it is. The answer is that, yes, provided you can meet the general eligibility criteria for both a personal loan and a home loan, your application should be approved. Those eligibility criteria may include:

  • Higher-income to show repayment capability for both the loans
  • Clear credit history with no delays in bill payments or defaults on debts
  • Zero or minimal current outstanding debt
  • Some amount of savings
  • Proven rent history will be positively perceived by the lenders

A personal loan after or during a home loan may impact serviceability, however, as the numbers can seriously add up. Every loan you avail of increases your monthly installments and the amount you use to repay the personal loan will be considered to lower the money available for the repayment of your home loan.

As to whether you can get a personal loan after your home loan, the answer is a very likely "yes", though it does come with a caveat: as long as you can show sufficient income to repay both the loans on time, you should be able to get that personal loan approved. A personal loan can also help to improve your credit score showing financial discipline and responsibility, which may benefit you with more favorable terms for your home loan.

What is a bad credit home loan?

A bad credit home loan is a mortgage for people with a low credit score. Lenders regard bad credit borrowers as riskier than ‘vanilla’ borrowers, so they tend to charge higher interest rates for bad credit home loans.

If you want a bad credit home loan, you’re more likely to get approved by a small non-bank lender than by a big four bank or another mainstream lender.

Where can I get all the information about an ANZ first home buyer’s loan?

As a first home buyer, you may require help and hand-holding, and as such ANZ has the buying your first home section on its website full of important information. ANZ also has a form in this section you can fill out to get a free consultation from an ANZ First Home Coach and create your own plan for buying your first home. This coach will help you understand where your current income is being spent and plan for your home loan repayments. You’ll get a clear picture of the costs involved in purchasing a property and how to budget or save for these costs. The coach will help you understand different deposit options and manage your accounts to enhance your savings.

There are three types of ANZ first home loans - Standard Variable, Fixed, and Equity Manager. The features, interest rates, and terms for each are different, and you can compare them here.

When they apply for an ANZ home loan, first home buyers can also get guidance on applying for the First Home Owner Grant (FHOG). This is a one-off government grant that may be available to you when you’re buying your first home. The eligibility criteria for FHOG differs between the different states and territories, which is why it’s helpful to have expert advice when applying.

Can I get a home renovation loan with bad credit?

If you're looking for funds to pay for repairs or renovations to your home, but you have a low credit score, you need to carefully consider your options. If you already have a mortgage, a good starting point is to check whether you can redraw money from that. You could also consider applying for a new home loan. 

Before taking out a new loan, it’s good to note that lenders are likely to charge higher interest rates on home repair loans for bad credit customers. Alternatively, they may be willing to lend you a smaller amount than a standard loan. You may also face some challenges with getting your home renovation loan application approved. If you do run into trouble, you can speak to your lender and ask whether they would be willing to approve your application if you have a guarantor or co-signer. You should also explain the reasons behind your bad credit rating and the steps that you’re taking to improve it. 

Consulting a financial advisor or mortgage broker can help you understand your options and make the right choice.

What is a debt service ratio?

A method of gauging a borrower’s home loan serviceability (ability to afford home loan repayments), the debt service ratio (DSR) is the fraction of an applicant’s income that will need to go towards paying back a loan. The DSR is typically expressed as a percentage, and lenders may decline loans to borrowers with too high a DSR (often over 30 per cent).