5 steps to get out of debt

5 steps to get out of debt

While a certain level of carefully-managed debt can help us make progress towards our financial goals, it’s easy for debts, fees and interest charges to grow larger than we can easily manage.

If you’re struggling with debt and don’t know where to start when it comes to getting your finances back under control, here are five steps you can potentially follow:

Step 1 – Get organised and make a plan

There are several questions you should ask yourself when making a plan to get out of debt:

  • What debts do you owe?
  • Who do you owe them to?
  • How do you owe on each debt?
  • How much are the monthly repayments?
  • What are their interest rates?
  • What are their due dates?

Once you have a better idea of your overall debt situation, you can prioritise which debts to focus on clearing first.

Step 2 – Focus on your smallest debts OR your debts with the highest interest rates

Trying to pay off multiple debts at once can prove both difficult and expensive. Depending on your financial situation, you may want to consider focusing on paying off one debt at a time, and only paying the minimum amount required to service your other debts. The question is, which debt should you concentrate on clearing first?  

One possible strategy is to put the lion’s share of your available budget towards clearing the debts with the smallest balances owing first. These relatively easy wins let you make clear progress towards your goal of becoming debt-free, and give you a valuable psychological boost that encourages you to stick to your commitment.  Also, every debt you fully clear is one payment to budget for, and one less set of fees and interest charges. The funds that once went towards servicing these small debts can then be put towards tackling your bigger, nastier debts.

A second possible strategy is to focus on paying back whichever of your debts has the highest interest rate. The longer you take to repay any loan, the more repayments you’ll have to make, and every repayment means another interest charge. By prioritising clearing your high-interest debts first, you may save more money in interest charges in the long run than paying off your smaller debts first. 

The ideal strategy for clearing your debts will depend on your situation, as well as your household’s personal finances. Make some calculations and use your best judgement to make a plan, and be prepared to stick to it.

Step 3 – Talk to your creditors

Nobody wants to see a borrower default on their loan, including the lender. If you’re struggling to afford your repayments, it may be worth talking to your creditors and being upfront about your current situation, rather than risking missed repayments that could leave you in serious financial strife.

Your lender may be willing to make some concessions to help you manage your debt situation, such as offering a repayment holiday or allowing you to refinance onto a more affordable interest rate.

However, your lender will need you to pay back what you owe sooner or later. If you are offered some debt relief, don’t use it as an excuse to relax and rest on your laurels, but refocus on clearing your balance owing as quickly and efficiently as possible.

Step 4 – Consider debt consolidation

If you owe money to multiple creditors, it’s worth considering whether consolidating your many smaller debts into one larger debt will leave you in a better financial position.

A debt consolidation loan is a type of personal loan where you borrow a lump sum of money that is used to fully pay off and clear your other existing debts. This leaves you with just one loan to manage, with one repayment each month, one interest charge at the one rate, and one set of fees to pay. This can greatly simplify your household budgeting, and potentially make your monthly repayments more affordable.

It’s important to note that a debt consolidation loan could ultimately cost you more in total interest than paying off your debts separately. This is because debt consolidation loans often stretch out your repayments over a term of 12 months or more. While you’ll make a larger number of smaller repayments, you’ll be charged interest on each of these repayments. In some cases, you may pay less in total interest by clearing your debts separately over a shorter period of time, even if the repayments are less immediately affordable.   

It’s also important to note that once you’ve cleared your old debts with the help of a debt consolidation loan, that doesn’t mean you can go out and run up new debts! Resist the temptation to go shopping with your now-cleared credit cards, and focus on your mission to become debt-free.

Step 5 – Get help when you need it

Getting out of debt isn’t easy or fun. It’s hard work, and can be a real struggle for borrowers in financial hardship.

Don’t be afraid to ask for help from professionals, such as accountants and financial advisers. If you don’t think you could afford their fees, the Australian government has free financial counselling services available, along with their National Debt Helpline – 1800 007 007.

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Learn more about personal loans

What is debt consolidation?

Debt consolidation is the process of rolling several old debts into one new debt, usually to save money or for the sake of convenience.

How do I consolidate my debt if I have bad credit?

The worse your credit history, the harder you will find it to consolidate your debts, because lenders will be less willing to lend you money and will charge you higher interest rates.

However, people with bad credit histories can make debt consolidation work by following this three-step process:

  1. First, find a lender willing to give you a bad credit personal loan. This process will be simplified if you go through a finance broker or use a comparison website like RateCity.
  2. Second, make sure the interest repayments on your new loan are less than the repayments on the loans being replaced.
  3. Third, instead of spending those savings, use them to pay off the new loan.

Can I repay a $3000 personal loan early?

If you receive a financial windfall (e.g. tax refund, inheritance, bonus), using some of this money to make extra repayments onto your personal loan or medium amount loan could help reduce the total interest you’re charged on your loan, or help clear your debt ahead of schedule.

Check your loan’s terms and conditions before paying extra onto your loan, as some lenders charge fees for making extra repayments, or early exit fees for clearing your debt ahead of the agreed term.

What are the pros and cons of debt consolidation?

In some instances, debt consolidation can help borrowers reduce their repayments or simplify them. For example, someone might take out a $7,000 personal loan at an interest rate of 8 per cent so they can repay an existing $4,000 personal loan at 10 per cent and a $3,000 credit card loan at 20 per cent.

However, debt consolidation can backfire if the borrower spends the extra money instead of using it to repay the new loan.

What are the pros and cons of bad credit personal loans?

In some instances, bad credit personal loans can help people with bad credit history to consolidate their debts, which can help make it easier for them to clear those debts. This is because the borrower might be able to consolidate several debts with higher interest rates (such as credit card loans) into one single debt with a lower interest rate and potentially fewer fees.

However, this strategy can backfire if the borrower spends the loaned funds instead of using it to repay the new loan. Another disadvantage of bad credit personal loans is that they have higher interest rates than regular personal loans.

Is a personal loan a variable or fixed-rate loan?

Depending on the personal loan lender, you may be able to choose between a fixed and a variable interest rate. But, there are a few distinct differences between the two, so it’s important to weigh up the pros and cons before deciding on what’s right for you.

A fixed interest rate loan gets you the convenience of knowing exactly how much you need to repay each fortnight or month. On the other hand, you generally won’t be able to make lump sum or advanced payments to close your personal loan early - or at least not without a penalty.

With a variable interest rate personal loan, you may be able to get a longer loan repayment term, with the option of paying off the loan early. You typically won’t need to pay any additional charges for an early full repayment either. The potential disadvantage with an interest rate that can change is that your repayment is not entirely predictable, as it can fluctuate with the market. However, you’ll likely have more options as more lenders offer a variable interest rate personal loan.

Does refinancing a personal loan hurt your credit score?

Personal loan refinancing means taking out a new loan with more desirable terms in order to access a more competitive interest rate, longer loan term, better features, or even to consolidate debts.

In some situations, refinancing a personal loan can improve your credit score, while in others, it may have a negative impact. If you refinance multiple loans by consolidating these into one loan, it could improve your credit score as you’ll have only one outstanding debt liability. Your credit may also improve if you consistently pay the instalments on time.

However, applying to refinance with multiple lenders could negatively affect your credit if your applications are rejected. Also, if you delay or default the repayment, your credit score reduces.

Can I get a $1,500 payday loan with bad credit?

Yes, it may be possible to get a $1,500 payday loan with bad credit. Some payday lenders give loans to people with bad credit histories if they believe the borrower has the capacity to repay the loan.

Under Australia’s responsible lending rules, lenders aren’t allowed to approve $1,500 payday loans if they don’t believe the borrower can make the repayments.

How can I improve my credit rating/score?

Your credit score will improve if you demonstrate that you’ve become more credit-worthy. You can do that by minimising loan applications, clearing up defaults and paying bills on time.

Another tip is to get the one free credit report you’re entitled to each year – that way, you’ll be able to identify and fix any errors.

If you want to fix an error, the first thing you should do is speak with the credit reporting body, which may take care of the problem or contact credit providers on your behalf.

The next step would be to contact your credit provider. If that doesn’t work, you can refer the matter to the credit provider’s independent dispute resolution scheme, which would be the Australian Financial Complaints Authority (AFCA).

AFCA provides consumers and small businesses with fair, free and independent dispute resolution for financial complaints.

If that doesn’t work, your final options are to contact the Privacy Commissioner and then the Office of the Information Commissioner.

Can I get a personal loan if I receive Centrelink payments?

It is hard, but not impossible, to qualify for a personal loan if you receive Centrelink payments.

Some lenders won’t lend money to people who are on welfare. However, other lenders will simply consider Centrelink payments as another factor to weigh up when they assess a person’s capacity to repay a loan. You should check with any prospective lender about their criteria before making a personal loan application.

Can I get guaranteed approval for a bad credit personal loan?

Few, if any, lenders would be willing to give guaranteed approval for a bad credit personal loan. Borrowers with bad credit histories can have more complicated financial circumstances than other borrowers, so lenders will want time to study your application. 

It’s all about risk. When someone applies for a personal loan, the lender evaluates how likely that borrower would be to repay the money. Lenders are more willing to give personal loans to borrowers with good credit than bad credit because there’s a higher likelihood that the personal loan will be repaid. 

So a borrower with good credit is more likely to have a loan approved and to be approved faster, while a borrower with bad credit is less likely to have a loan approved and, if they are approved, may be approved slower.

What causes bad credit ratings/scores?

Failing to repay loans and bills will damage your credit score. So will falling behind on your repayments. Your credit score will also suffer if you apply for credit too often or have credit applications rejected.

How long does it take to get a bad credit personal loan?

In the best-case scenario, an application for a bad credit personal loan can be made within minutes and then be approved within 24 hours. However, if a lender needs more information or needs more time to verify the provided documents, the application process may take longer.

How are credit ratings/scores calculated?

Different credit reporting bodies may use different formulas to calculate credit scores. However, they use the same type of information: credit history and demographic profile.

They’re likely to look at how many credit applications you’ve made, which lender the applications were for, what purpose they were for, how much they were for and your repayment record. They’ll also look at your age and postcode. They’ll also look to see if you’ve had any bankruptcies or other relevant legal judgements against you.

Your score can change if your demographic profile changes or new information is added to your file (such as a new loan application) or existing information is removed from your file (i.e. because it has reached its expiry date).