How to pay off lingering debt from festive season
Christmas often means big bills for many people. Whether it’s the supermarket shopping for a dinner for the whole family or presents for the kids, it all adds up.
Last year, New Zealand’s combined credit card balances peaked at just under $7.5 billion in December, before slowly dropping back to just under $5.8b by April.
If you’re coming out of the festive season owing more than you would like, there are a few things you can do.
The first is to assess exactly what you owe and to whom. It can be easy to get caught up in the whirlwind of festive purchases and not pay attention to just how much is being loaded on the credit card, Afterpay or hire-purchase agreements.
Make a note of what you owe, the interest rates on that debt and the payments required. That will help guide your strategy as you pay it off.
Financial coach Hannah McQueen recommends paying off the debt with the highest interest rate first, because this is the most expensive to hold.
‘‘That debt will grow the fastest if you do nothing. If you can get it all on to a low interest rate then that should free up your surplus to channel more into the debt repayment,’’ she said.
‘‘But paying off debt is as much a mental game as it is financial. Sometimes, if you have little debts, even if the interest rate is lower than some other debts, paying them off quickly to remove them from your list of debts is a way of getting a quick win, which helps build the momentum of progress.
‘‘The other option, again playing more to your psychology of money, is to pay down the debt that has the largest monthly repayment attached to it. Sometimes this is the largest debt, but often it isn’t. In clearing this debt first, it has a disproportionate impact of your surplus and the momentum you can then build – so you have a sense of nailing things quickly – which helps you remain engaged with the process.’’
While debt like Afterpay or hirepurchase deals will have set repayments each fortnight or month, credit cards will only ask you to make a minimum payment. This can be an expensive trap.
When you do not pay your balance off in full each month, interest starts to be applied and is routinely anything up to about 20 per cent a year.
If your credit card has a balance of $1000 and you only pay a minimum 2 per cent each month, it will take 16 years to pay off the full $1000 and there will be an added $2000 in interest on top of the original bill, financial research site Moneyhub calculates.
McQueen suggested it could make sense to look for a low-interest balance transfer option. Some banks offer these deals to people who move their credit card debt over. Anther option is to switch to a low-interest credit card.
‘‘The best option for you depends on how fast you can get the debt repaid – so you need to do some maths to see how much you can dedicate towards reducing the debt each month,’’ McQueen said.
‘‘The main fishhook here is the [balance transfer] offers tend to only be available to new customers, you’ll have to switch providers to be eligible. What the balance transfer doesn’t address is the issues and spending behaviours that created the debt in the first place.
‘‘So, at a minimum I’d suggest lowering your credit card limit as you reduce your debt – or better yet, cutting the card up so you can’t add to the balance, as that will incur the ordinary interest rate and put your progress back further.’’
You may see debt consolidation loans advertised after Christmas. These are designed to allow people who have amassed multiple debts with a range of providers to combine them on one loan with one payment. This can feel less overwhelming, and easier to keep track off.
Debt consolidation might be a good idea if the interest rate is lower than the existing loans or if there is a risk you will otherwise fall into arrears. But if it just means you stretch out the loan for longer, you may end up paying more in total.
‘‘I’d want to know that the consolidation loan offered the best interest rate you could get, that there weren’t exorbitant fees for repaying that loan early, and that you weren’t going to end up paying more in interest because the loan simply stretched your repayments out over a much longer time period. With mortgage interest rates so low it may also be worth considering whether you could get a top up on your mortgage,’’ McQueen said.