5 steps for reducing high-interest debt

5 steps for reducing high interest debt

High-interest loans are generally for assets that people want to acquire quickly, but that immediately start depreciating in value, such as a car. Or for when there’s technically no asset at all, like a holiday, furniture or large appliances.

“It’s the car loans that are really a problem in my opinion,” says Melinda Houghton, principal of Victorian financial planning firm Houghton Strategic Solutions. “I saw a car loan just the other day that had interest rates of 12 per cent. That’s quite high when you consider a lot of credit cards are 12 per cent, and a car loan’s actually a secured debt, secured by the car.”

For some unsecured loans, where the bank is relying on your creditworthiness rather than an asset, people can be paying anything up to 18 per cent interest depending on the provider.

Melinda recommends 5 steps for ridding yourself of the pain of high-interest debt.

1. See a bank or provider about consolidation

“By reducing multiple personal loans or credit cards into one lower-interest debt you should be able to save on the interest cost,” Melinda says. ”It’s also easier to manage because you’re now making just the one repayment. It can look better on your credit history as well, if you have a lower quantity of debt.”

But first you’ll need to review your asset and income position to make sure you’ve got more in assets than you actually owe. “That’s what a bank will want to see when you’re talking to them about consolidating or re-financing,” Melinda says.

Banks and other providers will also look at your ability to service a loan, doing calculations based on your income. “And if there are multiple applications for credit over a short period on your credit history that could go badly for you,” she says.

By reducing multiple personal loans or credit cards into one lower-interest debt you should be able to save on the interest cost.

2. Stop spending money on “wants”

Look at where your money is going and why you got into that position in the first place. Is it discretionary spending like holidays, clothes, shoes, bags or tech gadgets? These are often wants, not needs.

“I often say to people, ‘what would granny have done?’ Granny would save up and have the money in the bank before she bought something. Whereas now we’re a lot more instantaneous as a society,” Melinda says.

3. Add to your home loan

Consider talking to a mortgage broker about rolling the debt into your home loan. This will potentially allow you to consolidate to the lowest possible interest rate.

4. Design a payment plan for existing debts

Melinda recommends looking at all your loans, of all types, using any extra money you may have to pay off the highest-interest loan first.

For example, after you’ve met all your minimum repayment requirements on all the loans, then any extra money you have, whether it’s $10, $50, $100 or $1000 – put that into the highest-interest loan until that’s paid off. And then you work on the next one.

5. Once your debt is consolidated, don’t trip up

Melinda says the biggest mistake people make is not getting rid of the old loans they’ve consolidated. “People go, oh I won’t use it, but then suddenly they’re back up in the position they were before with an extra debt involved.”

Also, people commonly consolidate into a mortgage with a low interest rate (currently around 4 to 4.5 per cent) but don’t actually pay more off the loan. So it can push out the term of the loan and it can actually cost you a lot more in the long run. So it sounds like it’s cheaper but it’s not.

As Melinda explains: “If you were paying off five credit cards before and the total was $1000 a month, and you consolidate into a low-interest amount, if you continue to pay that $1000 you’re going to get rid of it a lot quicker.”

For more advice on how to get on top of your finances and eliminate financial stress in your life, check out our blog