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Conquer Your Fear of Debt

Fear of DebtConquer Your Fear of Debt

When it comes to confronting your financial fears, the ultimate four letter word is debt. For many households, debt it is the single biggest contributor to stress. It has the power to destroy relationships and even lives. Everybody’s tolerance of debt is different.  Problems occur when two people in a relationship have different views about debt, or when debt repayments cause financial hardship. If debt is dragging you down or causing fear, here is how to confront it.

 

  1. Make a list of all your current debts, the interest rate you are paying on each debt and the minimum repayments. Your first priority is to make the minimum repayment on all debts. The next priority is to make additional payments over and above the minimum on the debt with the highest interest rate. Once that is paid off, start on the debt with the next highest interest rate and so on.
  2. It goes without saying that if you are struggling with debt, you shouldn’t take on more debt. If things are getting out of hand it is tempting to borrow more to keep up repayments. Instead of this, negotiate a new repayment arrangement with your creditors or refinance over a longer term.
  3. Free up more money to pay off debt. Make a list of everything you spend in a month and look at what you can cut back on. Personal items, groceries and subscriptions to services you no longer use are the easiest areas to target.

Be smart with your borrowing. Borrow only what you have to, for the shortest amount of time at the lowest possible interest rate. Shop around for the best deal rather than the one closest to hand. Don’t borrow up to your limit; leave some wriggle room in case something unexpected happens.

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Borrow with Caution

Borrow with CautionBorrow with Caution

When interest rates are low and property prices are rising rapidly, it is tempting to borrow more. There is a huge psychological effect on property owners when house values rise. They feel wealthier, and more confident. This can lead them to spend more or take on risky ventures and this often means borrowing money. It is hard to get through life without borrowing, but there are some basic principles to follow.

Only borrow what you need and only for essentials

The cost of a purchase is always greater with borrowed funds, so keep borrowing to a minimum. You may need to borrow to buy a car but it doesn’t have to be a late model car. Travel, clothes, new smart phones are all nice to have but borrowing to enjoy life now just makes your life less enjoyable later on.

Pay it off on time and as quickly as possible

While mortgage interest rates have dropped significantly, standard credit card interest rates are still around the 20% mark and store cards are around 25%. Only borrow on cards what you can pay off within the interest free period.

Find the cheapest source of borrowed funds

If you have to borrow for essential spending, shop around for the best deal on interest rate and other borrowing costs. It’s better to borrow at mortgage interest rates of 4-5% than to pay credit card and store card interest rates.

Borrow to invest

Investors who are disillusioned with bank term deposit rates are turning to property investment, using their available funds or home equity as a deposit and borrowing the rest. With percentage property value increases higher than interest rates, this makes sense. Caution is needed as interest rates may increase in the medium term and property values may eventually stagnate or even fall.

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Tips for Lending Money

LoansTips for Lending Money

When money is tight, family and friends are often called upon for a loan. It’s nice to help people but lending money on an informal basis can be a recipe for disaster. Here are some of the problems that could arise:

  • You may not be able to enforce repayment and if problems occur, your relationship with the borrower may become very difficult
  • You may end up in the same situation as the borrower if things go wrong
  • You may have to declare any interest as income in your tax return
  • The borrower may use your money for a different purpose than what you lent it for
  • The borrower may already have a large amount of debt that they are struggling with
  • The borrower may die, become seriously ill or have a relationship breakdown before they repay you.

If you are convinced that you need to lend the money, here are some tips to ensure things have a better chance of going smoothly:

  • Get to know the true financial situation of the borrower
  • Ensure the money is used as agreed, for example by making the payment directly to the third party
  • Ask for evidence that other options for borrowing have been explored
  • Don’t lend money you can’t afford to lose
  • Have a written agreement signed by all parties to record the purpose and amount of the loan, the rate of interest, the frequency and amount of repayments, the time frame for repayment and how late payment will be dealt with
  • Encourage the borrower to make repayments by regular automatic payment.

Money is easily replaced – relationships with good friends and family are not. Lending money to people you know should be done as a last resort and with extreme caution.

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Using Interest-Only Mortgages

BNZUsing Interest-Only Mortgages

An interest-only mortgage, as the name suggests, is one where no principal repayments are required to be made during the term of the loan. It is usual for an interest-only mortgage to be interest-only for a fixed period of time, such as two years or five years, after which it can either be converted to a table loan (principal and interest) or rolled over as interest-only with the approval of the lender.

The key advantage of an interest-only mortgage is that the minimum repayments are less. They can be particularly useful for:

  • First home owners for whom mortgage repayments are a big percentage of income
  • Home owners who have a change in circumstances such as a sudden loss of income due to illness, redundancy, death of a partner or birth of a child
  • Retirees or others on low incomes who need to borrow money to maintain their property or to cover essential living costs
  • Home owners who have a significant amount of short term debt with very high monthly repayments
  • Property investors for whom the interest on mortgages is tax deductible

Getting rid of debt on the home you live in should be a priority and so the use of an interest-only mortgage should be a last resort or a temporary measure for when money is tight. For property investors who still have a mortgage on their own home, it makes sense to use all spare cash to reduce the principal of the home mortgage for which the interest is not tax deductible. Property investors for whom the interest on all debt is tax deductible may choose to still leave their mortgages as interest-only and invest the equivalent of the principal repayments elsewhere for a return higher than the net cost of interest after tax.

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Microfinance for Low Income Families

OnecentMicrofinance for Low Income Families

Two of the toughest financial issues for people on low incomes are getting access to loans at an affordable interest rate and getting rid of high-interest, short term debt. That’s where microfinance comes in. Microfinance is the provision of financial services such as loans and savings accounts to people on low incomes who can’t easily access mainstream financial services. Loans generally have either a low interest rate or no interest and are for small amounts. Access to microfinance helps people on low incomes become financially independent and in turn, this makes a significant difference to their well-being, dignity and confidence.

Microfinance, particularly lending for small businesses, is burgeoning in developing countries. World Vision Micro and Kiva are two examples of microfinance organisations offering loans to entrepreneurs in poor areas. However, microfinance is also prevalent in developed countries. In Australia, Good Shepherd Microfinance offers low or no interest loans which help households with essential living costs, like fridges, education or medical expenses. Good Money, a joint venture between Good Shepherd, the National Australia Bank and the State Government of Victoria, has a number of community finance stores which offer financial counselling as well as financial services. They also provide advice on energy efficient products and a discount buying service for household goods such as whiteware.

In 2012, the Good Shepherd New Zealand Trust was established with the aim of developing microfinance in New Zealand. In conjunction with Kiwibank, Good Shepherd is supporting the development of No Interest Loan Schemes, the first example of which is the Nga Tangata Microfinance Charitable Trust in South Auckland.

In May 2013, the New Zealand Government announced an initiative to build financial literacy and to work with financial institutions and non-government organizations to provide microfinance services to low income families. Further announcements are expected later this year.

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Record Lows for Mortgage Interest Rates

PercentagefallRecord Lows for Mortgage Interest Rates

It has been many years since we’ve seen mortgage interest rates so low. That’s great news for first home buyers and investors in particular. Banks appear to be in a bidding war to attract borrowers. Meanwhile the Reserve Bank is in the process of implementing measures to restrain mortgage lending so as to reduce the risk of house price inflation.

Borrowing money at a low interest rate is both an opportunity and a threat. Interest rates move in cycles. Borrow at the low point of a cycle and it goes without saying that over time, interest rates will increase, thus increasing your mortgage payments.

There are steps you can take to protect yourself when borrowing at low interest rates.

While it is tempting to take advantage of lower rates to borrow as much as possible, your repayments may become unaffordable when interest rates increase. It is sensible to leave yourself some wriggle room by borrowing an amount that you know will be affordable when interest rates rise by a couple of percent.

Fixing the interest rate for the whole of your mortgage for a period of time can create uncertainty about what the interest rate will be at the end of the period. To reduce this uncertainty, consider chunking your mortgage up into two three amounts which are fixed for different periods of time. That way, if rates go up, only part of your mortgage will be affected at any one time, thus spreading the impact of higher mortgage repayments.

While it may seem a good idea to lock in a low interest rate for long period of time, be aware that if your circumstances change and you need to sell your property or repay your mortgage for some other reason, you may be charged a penalty for early repayment.

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Managing Your Student Loan

Managing Your Student Loan 

For first year tertiary students, one of the most daunting challenges is how to get financial assistance without being burdened with a lifetime of debt. A student loan is inevitable for most students.

Student loans are available for compulsory course fees, course related costs and living costs, subject to eligibility criteria. There is no interest charged if you are based in New Zealand and if you make the required repayments on time once you are earning above the income threshold.

If you are living overseas, interest is charged (currently 5.9%). Borrowers who go overseas can apply for a repayment holiday of up to a year after which they make two compulsory payments a year totaling up to $3,000 depending on the size of the loan.

For as long as the loan is interest free, it makes sense to use a student loan rather than use money that is saved or invested and earning a return. An interest-free student loan can be thought of not as a loan, but as a deferred tax liability. Loan repayments have the same effect for the borrower as paying a higher rate of income tax until the loan has been repaid. In theory, a tertiary qualification should result in higher earning power which will offset the loan repayments.

The key principles for managing a student loan are:

  • Borrow only what you need
  • While the loan is interest free, pay off only what you are required to pay and save as much of your income as you can towards your financial goals
  • Make required repayments on time to avoid penalties
  • If interest is charged, for example if you go overseas, pay off your loan as quickly as possible

Adhering to these principles will ensure your student loan works well for you.

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Wriggle Room

Wriggle Room

One of the traps of borrowing money in a low interest rate environment is not leaving enough spare money, or ‘wriggle room’ in your budget to cope with an increase in interest rates. This is particularly important to consider when you are buying your first home, upgrading to a more expensive home, or increasing your mortgage to pay for a new car or overseas holiday. There are several ways you can protect yourself from the effects of future increases so you don’t run out of money.

 Plan for an increase

When you are looking to increase your borrowing, do your budget based on loan repayments at a higher rate of interest. You will be able to pay off your mortgage more quickly while interest rates are low, and you can choose to keep you repayments at the same level if interest rates rise.

Have access to spare funds

Don’t borrow up to the maximum of your borrowing capacity. If things don’t go according to plan, you will have the option of increasing your borrowing. Have some savings set aside, preferably in an account where the savings will offset your mortgage to keep your interest payments down. Alternatively, have a line of credit into which you can put your savings. This has the effect of reducing the interest you pay while still having access to your funds if necessary

Fix the interest rate

Fixing the rate on at least part of your mortgage will give you certainty about your repayments. You may or may not save on the amount of interest you pay, but at least you will not be caught out with an unexpected increase in loan repayments. Remember that if you need to break the fixed rate, for example by selling your house, you may be charged a penalty.

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