Lesson 4.3

5 small steps to manage your debt

Most of us borrow money at different stages of our life, so being able to manage those debts confidently and responsibly is a key part of our financial fitness journey. 

There are many different reasons why we might borrow. It could be to buy a car, a home or a holiday, and there are lots of different loans available to us, such as car loans, personal loans, home loans or investment loans. 

Healthy debt helps you grow your wealth, and unhealthy debt detracts from your wealth. Learning to spot the difference between the two is key. 

Prioritise paying off debt that attracts a high rate of interest by following the five steps below. 

Once achieved, you can speak to a lender to help you start exploring how to responsibly use debt to finance the purchase of assets, such as a home or shares, to potentially drive your wealth building journey.

Step 1. Write a list of what you owe 

The first step to taking control of your debts is to write out a list of all debt held in your name, including credit cards, personal loans, car loans, home loans and investment loans. 

List the name of your lender, the outstanding balance and the interest rate you are paying on each. You can do this on a spreadsheet, or on paper. 

It can help to order your list, either from smallest debt to biggest, or from highest interest rate to smallest.  

Step 2. Understand your debts 

When you’re taking on debt it’s important to know what type it is.  

Firstly, you should know if your debt is ‘secured’ or ‘unsecured’. Secured debt is a loan you take out against an asset, whether that’s your home or a car. Unsecured debt is borrowing to fund your current consumption, including credit cards or personal loans. If you default on your payments, there is no underlying asset for a lender to access, and that’s why these types of credit can come with a much higher rate of interest. 

You can further breakdown your debts into those secured against an ‘appreciating’ or ‘depreciating’ asset. An appreciating asset is one where you might expect the value of that asset to increase over time, for example property or shares. A depreciating asset is one you might expect to decline in value over time, such as a car. 

Generally, we want to have our debts held against assets that are likely to appreciate in value over time.  

Step 3. Choose a debt pay down method 

Once you have identified some debt you want to pay down, there are two broad approaches you can follow. 

The first method is the ‘snowball’ method. This is where you start paying off your debts with the smallest balances. It can give you a sense of accomplishment when you get to close an account, and this will help build the confidence you need to keep chipping away at the next, bigger debt.  

The second method is called the ‘avalanche’ method. This is where you start by paying off the debt with the highest interest rate applying. It may take a little longer to get your first ‘win’, because your highest interest debt may also be your biggest outstanding balance. But, over time, you’re going to save the most on interest by paying off the most expensive debts first. 

Step 4. Make excess repayments on your chosen debt 

Once you’re committed to a debt pay down strategy, it can help to automate payments so that you’re making higher than minimum repayments.  

Try to live so that you are spending less than you earn and then divert some of those savings towards debt reduction. 

You could also use any unexpected windfalls, such as a tax refund, to reduce your debts.

Step 5. Seek support 

Speak to your lender about potentially consolidating your debts or arranging an altered payment plan. If you have a credit card debt attracting a high rate of interest, inquire about newer credit cards with zero-interest options.  

Rising costs or a change in circumstances can impact your finances at any time. Financial hardship is when you’re unable to make repayments on a debt or pay for other basics, like utility bills. This can occur due to cost-of-living pressures, unemployment, relationship breakdown, natural disasters and other unforeseen situations.

Anyone can experience financial hardship and support is available. You can speak to your lender or other biller directly – they have obligations to help. And if you need more support to manage your debts, you can always call the free and confidential National Debt Helpline on 1800 007 007. 

Of course, it’s to be expected that life is going to throw us some curveballs, but seeking support is one of the most important things you can do on your debt repayment journey.