Sometimes our clients have got a debt consolidation loan and have paid out their debts but haven’t closed the accounts. These accounts start to accrue fees and charges, mainly through having direct debits dishonouring repeatedly on these accounts.  With no payments penalty interest rates kick in and the balance of the zombie debt grows.

The second way zombie debts occur is when a creditor might sell, or “charge off” its overdue debts to a debt collector who starts fresh collection activity.  This might happen years after you thought it was dead and gone.  Suddenly 10 years latter you’re getting calls, letters and legal action.

There is a statute of limitations on debt of 6 years. So if you haven’t heard from your creditors for 6 CONTINUOUS years, the debts is gone.  However if you didn’t update your contact details with that creditor, the statute of limitations doesn’t apply.  The statute of limitations is 12 years if the creditors have successfully obtained a judgment for the debt.

Zombie debts don’t go away unless you pay them. Just like zombies keep coming back to life in horror films, to make sure they’re dead, CLOSE THE ACCOUNTS!

The average saving on a $10,000.00 credit card, when consolidated into a personal loan, is only $5.00 per month, over 7 years.  This means debt consolidation doesn’t provide much of an improvement in cash flow.  The question you’ve got to ask yourself is, “is it going to be easier for me to find one large payment or lots of little payments?”

You may be able to find a spare $20.00 here and there to make a payment on your credit cards, but it may be a lot harder to find $100.00 to make a payment on your debt consolidation loan.

You’ve also lost the ability to negotiate with a large number of creditors.  You might be able to call one creditor and get them to push back your payment for a week, but you can’t do that now that you’ve only got one creditor.

For many debt consolidation is a good idea, but you need to think about the reality of the situation.

Reserve Bank data shows that interest rates on personal loans has been steadily climbing and the last time it was this high was June 1993.  But I hear you say “aren’t interest rates at emergency lows?”  Yes, if its a home loan, but banks quietly jacked up or failed to drop their interest rates on credit card cards and personal loans to offset the losses from home loans.  If you don’t have assets (i.e. a house) the benefits of consolidating your debt haven’t been this small since May 2002.

People may be not be able to consolidate their debts, and affordability declines. Debt consolidation affordability is based on the interest rates on personal loans (debt consolidation loans).   As interest rates rise the affordability decreases, expressed another way the repayments are higher to borrow the same amount of money.  This obviously will prevent people from consolidating their debt and they may have to look at other options like debt agreements, mortgage refinancing, and informal arrangements.

Approving loans really hasn’t changed much in 100 years.  In the banking industry it’s referred to as the 4 C’s of Credit; Character, Capacity, Collateral, Conditions.  The 4 C’s matter.

Character

This refers generally to your credit history but it also takes into account your education, where you live and how long you’ve been there, and your marital status.

Example, young single man, moves every 3 months vs Man in 5 year De Facto Relationship lived in same house for 5 years.  Who would you give a debt consolidation loan to? That’s right, Mr Stable.

Capacity

Refers to your income AND your expenses.  If your expenses are high, then you have less money available for paying the debt.  Lenders will also look at if you have appropriate insurances available in case you get sick or die (sorry but it’s the truth).

Collateral

How much money and stuff do you have.  You’ve been working for many years now; lenders want to know what you did with all the money.  Did you spend it on bonds and shares, or did you spend it on beer and skittles? The more you have to show for your income the more likely you are to be approved for a debt consolidation loan.

Conditions

It’s not ALL about you, when banks are approving debt consolidation loans.  Some of it has to do with economic conditions, e.g. recessions! Other things might be the economic conditions in your industry; say, you’re a roof insulation installer and the government just cancelled a rebate for installation. How likely are you to get a debt consolidation loan?

If your debts are above $50,000 and you don’t have property with equity to refinance, you won’t get a loan.

If you have any kind of default these days (even $100.00 electricity bills), you wont get a loan.

Don’t have a full time job? Or only been with your employer for a short period of time. You won’t get a loan.

Owe any “non-bank lenders” eg Cash Converters, Fast Access Finance? You won’t get a loan.

With bank lending more cautious than ever, unsecured debt consolidation loans are difficult to come by and it’s important to be aware of what else you can do to break free of your debts.

Debt Consolidation can only help you become debt free faster because your repayments are higher. If you want debt consolidation to help you get your repayments down, this can only happen by consolidating into a home loan, which extends the term and ends up with you repaying more. If you’re having trouble managing multiple payments are you going to find it easier to make one large debt consolidation loan repayment?

Debt consolidation isn’t a bad thing, but it isn’t a miracle financial cure. Just be clear about WHY you’re doing it.

The theory behind debt consolidation is that a single new loan is taken out to pay off your previous debts, often credit cards and personal loans. The idea is that the consolidated debt has a lower interest rate than your previous debts, and so you save money over time.

However, it’s not always as simple as that.

Debt consolidation can result in you paying a lower rate of interest, but if you consolidate all your debts into a secured debt such as your mortgage, you can end up paying back more, given the extended repayment period.

For example, on a debt of $10,000.00 taken out as a personal loan over 5 years at 11% interest you will repay a total of $14,333.51. However, the same debt, repaid as part of a 30 year mortgage at 6% will result in you repaying $23,710.30 – a difference of $9,376.79 dollars. However, if cash flow is your main problem, then the lower weekly repayments may outweigh the fact that you pay back more over time. It just depends on your circumstances and that’s why it’s important to get expert financial advice before you decide whether debt consolidation is right for you.

Balance Transfer- If you have credit card debt, balance transfer can look like a tempting debt consolidation option.   Understand that any new purchase on the new card will attract full interest, and any payments you make go on this new debt first, not on the old debt.  There will be a fee for this service, generally 1% of the full balance of the debt.  After 12 months the low interest rate reverts to the standard variable rate and you’re back to where you were.  There may also be exit fees if you leave.

Debt Consolidation Trap 2

Ghost Debt – After the debt is consolidated the debts are not automatically closed.  These ghost debts can come back to haunt you.  They continue to accrue fees and charges.  Worse still, many people will use these debts for unexpected expenses.  After a couple of years of unexpected expenses you may end up with more debt.

Debt Consolidation Trap 3

Low Monthly Repayment/Long Terms – Lower repayments mean one of two things, lower interest or a longer term.  If the term is longer the repayments may end up being greater.  This is especially true of consolidating debt into home loans through refinancing.

There is Hope

Credit Cards and personal loans are big predictors because it means a) you’re not actively working on your retirement and b) you’re living beyond your means.   Once you’ve realised that there’s a problem, you can start doing something about it.  The first thing you need to do is NOT to start saving.  The first thing you need to do is to become debt free as quickly as possible.   Debt consolidation, mortgage refinancing and debt agreements are all strategies to accelerate debt repayment (more information on these is in the debt solution section).  You need to do something quickly though.  Wait 5 years and over 30 years it may cost you more than $100,000.00.

How much do you need to avoid being on the pension?

To have an purchasing power equal to the average Australian and you were retiring this year you need $1,100,000,00 invested, not including your house.

Below is a table of what you need invested to retire on $50,000.00/year.

Obviously if you want to retire on less you need less.  If you want to live on $25,000.00 you only need $500,000.00 invested.

How am I going to get that much money?

To start with, you’re not going to get that much money by putting it in a bank.  There is generally considered to be two asset classes: Stocks, and Property, which you’ll need to invest in.  Everything else is a combination of these.  Your Superannuation Fund invests in stocks and property on your behalf.  You will need to make regular weekly investments in order to accumulate wealth.  If you’re interested in learning about wealth accumulation, a good start is Noel Whittaker’s book, “Making Money made Simple”, which is essential reading and has been for the last 20 years.

Why you REALLY don’t want to be on a pension

Currently there are 17 pensioners per 100 workers.  By 2050 there will be 33 pensioners per 100 workers.  Health care iscurrently 9.1% of GDP; by 2050 it will be 21%.   To maintain the current pension rate, income tax will have to increase by 31%, which can’t happen.  If real wages go down by 30% people won’t be able to afford housing or consumables which will ruin the economy.  The only option is that provision of health care and the pension will decrease substantially, by more than 50% if current tax rates are to be maintained, which is likely considering Australia is THE highest taxed nation on earth, or taxes will have to increase by more than 31%.  So if you’re struggling to make ends meet now, how are you going to make ends meet on $335.95/fortnight for a single and $253.25/fortnight per person in a couple?

I want to make it clear that there are “good debts” and “bad debts”. A “good debt” is a debt for an asset that appreciates (goes up) in value; a “bad debt” is every other debt. Home loans, margin lending loans are “good debt.”  Car loans, holiday loans, using your credit card for day to day purchases are all “bad debts.”

These days, having bad debts has been normalised. “Everyone owes a little bit of money on their credit card.”  In fact Australians owe over $43 Billion on their private credit cards. How did that happen? Well, contrary to what the media is saying it’s not “extravagant living.” They’re not guzzling champagne on overseas holidays. In fact, most people get there by spending 2-3% more than they can afford to year after year. Before you know it there’s $10,000.00 on your credit cards and you’re in trouble. So what do you do? Debt Consolidation?

Debt Consolidation is now talked about like it’s the responsible thing to do if you’ve got a lot of debt. Like getting organised, going to the doctor regularly or getting your car serviced. In reality it’s more like getting open heart surgery. You’ll avoid death, have a slight improvement in your quality of life and feel the effects for years to come. Many people associate debt consolidation with debt reduction, but all debt consolidation does is package multiple debts into one big debt!

In fact, debt consolidation can be one of the biggest mistakes people make. If they’re consolidating debt into their home loan, they’re turning short term debts into long term debts and they will pay back thousands more in interest. Debt consolidation with a personal loan will be paid back over 7 years. Debt consolidation with a home loan will be repaid over 30 years! Sadly, the only thing that will get you out of debt quicker is paying more!

The sad fact about debt consolidation is that in our experience in about 80% of cases people will be in a worse situation just a few years later. Debt consolidation doesn’t change peoples spending habits. Most people continue to spend 2-3 percent more than they can afford to, and they will continue to use the credit cards they put in the debt consolidation loan. We see dozens of cases a week where the client has a debt consolidation loan and has maxed out their credit cards again.

Debt Consolidation isn’t a miracle cure that many people expect it to be.