Avalanches snowballs
Snowball theory
The problem with paying off the highest interest rate first is that sometimes that’s a really big loan and it takes a long time.
‘‘Psychologically, people get good feedback when they have a quick win,’’ says Tom Hartmann, a personal finance editor at Sorted. ‘‘Sometimes it’s better to use the ‘snowball method’.’’
This means you pay off the smallest loan first, feel good about that, and move on to the nextbiggest loan. This can be a good way to sustain the momentum required to stay on course.
Barnett said it should be noted that more interest would be paid overall by those using the snowball plan.
Debt consolidation
If you have a lot of payments coming out of your account for your various loans and credit cards, it can be tempting to take a debt consolidation option. This should be done carefully. You will end up better off only if you are shifting to a lower rate, the term will be the same or less, and you are sure that you will not just rack up more debt once you’ve consolidated what you have.
Hartmann said he often saw people who had moved credit card debt on to a cheaper or zero interest card, but then carried on using their normal card in the same way, adding debt again.
‘‘They leave the card open so they are going to end up with more debt in future. It doesn’t achieve what you want.’’
Aucklander Golnaz Bassam Tabar was upset to be asked if she wanted to transfer her credit card balance to a personal loan to consolidate the debt – but the loan rate was to be 19 per cent, compared to the credit card’s 13.45 per cent. ‘‘No, thank you.’’
Koh said anyone struggling with payments might consider switching to a longer term once the debt was consolidated.
Putting debt on your mortgage is only a good move if you can pay it back over a short term.
If you take 20 years to pay it back, even a 5 per cent interest rate is expensive.
Not a bank customer?
Banks offer some of the lowest interest rates on loans.
If you do not want a loan from a bank, or do not meet their criteria, you may have to pay a higher rate from a consumer finance lender.
If you’re taking out a new loan, ask not just what the repayments will be each fortnight but also what you’ll pay overall in interest compared with the amount you initially borrow. Peer-to-peer lenders can be a cheaper option, although their interest rates are set on a risk basis. This means that if you have bad credit you will pay a higher rate.
Avoid short-term payday loans unless you are absolutely sure that you will have extra money within the next couple of weeks to repay the debt. With rates of about 1 per cent per day, these loans become extremely expensive very quickly.
In trouble?
If you are really in strife and struggling to pay, talk to the lender as soon as possible. They may help you work out a payment plan so you do not get charged penalties, or have your purchases repossessed.
Under the Credit Contracts and Consumer Finance Act, borrowers have the right to ask for the term of a loan to be extended, for a repayment holiday, or for the term of the loan to be extended, if they have suffered hardship.
That covers events such as illness or job loss. You’ll need to do this promptly because you cannot apply if you have been in default for two months or more, or been late with four consecutive payments.
These sorts of changes will increase the amount of interest you pay overall, in most cases.
Koh said people should deal with the causes of short-term debt, so that they did not end up back in the same position.
‘‘Build up an emergency fund for unexpected expenses or loss of income, and make a budget to keep your spending within your income.’’
‘‘Most people struggling with debt are juggling with amounts owing on credit cards, and personal loans that are stubborn to shift.’’
Tim Barnett of the National Building Financial Capability Trust