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Syndicated column 24 March 2012 - How to join the new debt cutting trend
We're all living through three "great transitions", said the keynote speaker at a recent conference. One transition is from West to East - with the growing emphasis on China and India, another is from analog to digital, and the third is from debt to saving. Let's look more at that third transition.
"The world is changing its mindset to frugality from profligacy," said Alan Kohler, chairman and editor in chief of Australian publications Business Spectator and Eureka Report, speaking at the ASIC Summer School in Sydney.
And the trend is not just because economies are sluggish. This is more than a cyclical change, it's something more permanent, said Kohler.
Others, too, have noted a tendency for people to pay down mortgages and other debt. And the huge uptake of KiwiSaver has turned more New Zealanders' minds to saving.
Such changes can be taken too far, of course. Without borrowing, many people would never own their own home or rental property or start a new business. But with borrowing comes risk. When things go wrong, you can end up without the property or business and still burdened with debt - something too many people have learnt in the last few years.
So how do we go about reducing our debt? Applying any lump sum you come by - from an inheritance, redundancy, lottery win or whatever - is a great idea. But chipping away slowly and steadily also works well.
The new calculators on the recently relaunched www.sorted.org.nz website give us some good examples:
• Say you have $5000 in credit card debt and they charge 20 per cent on it.
If you stopped running up any more items on the card, and repaid it at $100 a month, you would end up paying a total of $10,840 - more than twice the original debt. And it would take you just over 9 years to get rid of the debt.
But if you boosted your payments by just $25 a month - less than $1 a day - you would pay the loan off in about five and a half years, and save more than $2500 in interest.
What does that mean? Well, you paid off the debt three and a half years early. If you kept saving the $125 a month through those three and a half years in an investment that earns 4 per cent a year after fees and taxes, you would accumulate more than $5,600.
You could perhaps use that to pay for items that you were previously putting on the credit card. Much smarter! Make a lifetime habit of saving before you spend and you'll be way better off.
• Say you have a $300,000 30-year mortgage, with a floating interest rate of 6 per cent.
Monthly repayments are $1798, and you pay a total of about $647,500 - again more than twice the original loan.
But if you boost your payments just a couple of hundred dollars, to $2000 a month, you'll repay the loan in 24 years, and the total interest will fall by more than $90,000.
What does that mean? This time, you paid off the loan six years earlier. Saving the $2000 a month through those six years in a 4 per cent investment would give you $162,000 extra. Nice.
Try your own numbers in the Sorted debt, mortgage repayment, mortgage manager and savings calculators to see how a relatively small change can add up over time. In each calculator, click in the yellow box to make the calculation.
When using the savings calculator, I suggest you turn off the "inflation adjusted results" at the top. While it's important to allow for inflation, I think this adjustment is a bit confusing.
* Mary Holm is a freelance journalist, part-time university lecturer, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and bestselling author on personal finance (see www.maryholm.com). Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary's advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. You can contact her at firstname.lastname@example.org, or by mail care of this newspaper. Please name the newspaper in which you read this column. Sorry, but she cannot respond directly to readers.
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