Managing debt has to be strategic
THE subject of debt is of concern at the micro and macro levels of societies globally so today I am putting the spotlight on the challenges and solutions in managing personal debts.
Regardless of age group and gender, getting out of debt is a goal that many desire but has been an uphill struggle for some people to attain.
Just last week I had the opportunity to interact with a young male employee who earns a decent salary but is heavily in debt. Although he contributes to a company pension plan, his ability to invest for the long term has been diminishing as he wrestles with mounting debts. His pension account is protected by the automatic salary deduction mechanism that is in place.
The scenario faced by this young employee is replicated in numerous organisations, with the bulk of some employees’ salaries servicing multiple loans. Debt consolidation is not always possible as that method sometimes results in high monthly debt repayment, especially within an economic environment of high-interest rates.
There are instances in which I recommend people focus on clearing debts before investing in stocks. When the debt load becomes manageable then more funds can be invested in long-term instruments; delaying regular contributions to the long-term investment in such cases is temporary. Managing debt has to be strategic as results need to be specific, measurable, achievable, realistic, and timely.
Debt consolidation is a popular debt management option that is requested by some borrowers who have multiple loans but is debt consolidation the right vehicle to solve the financial problems? Debt consolidation involves combining outstanding loans into one monthly payment. However, there are pros and cons to debt consolidation.
Let’s examine the pros. Having one monthly payment replacing multiple monthly payments for several loans provides an advantage for the borrower who is now able to clear several loans and has just one loan to repay monthly. Such a borrower has the peace of mind of knowing that his/her credit score is protected. It reduces the risk of missing loan payments and contending with varying interest rate charges. The individual who has a debt-free goal now has a clearer timeline to get out of debt.
For individuals whose debt consolidation loans result in reduced interest when compared to the interest accrued from the separate loans, the resultant savings can be used to pay down the debt, thereby closing the debt consolidation loan at an earlier date. This option will only be beneficial if the aim is to pay off the loan early, which also aids in less interest being paid since debt consolidation loans usually have long repayment periods. Monthly payments may be reduced under a debt consolidation arrangement as payments are spread over a longer repayment period.
On the other hand, debt consolidation may bring additional challenges for the borrower. If the borrower has a low credit score then the borrower may be forced to accept a higher-than-normal interest rate for the debt consolidation loan. This means the borrower pays more interest payments for the duration of the loan. Additionally, even though monthly payments may be lower for a debt consolidation loan, because of the extended repayment period the borrower may make more interest payments for the duration of the loan. Borrowers can make higher monthly payments to avoid extra interest payments.
Avoid missing loan payments as this can be damaging to your credit score and may also attract additional fees. Communicate with the lender any potential challenges that may impact repayments. At best, payments should be automated. However, debt consolidation may not be ideal for all borrowers. It can lead to overspending for the borrower who is not prudent and who is under the delusion that funds are available since loans were cleared, only to find themselves heavily in debt again. Make sure that monthly expenses can be paid comfortably in tandem with the monthly payments for the debt consolidation loan.
I recommend that as soon as debts are paid off, saving and investing should increase, instead of building debt. Keep an annual check on your credit score; create assets instead of increasing liabilities these habits will keep you out of debt. It’s important to develop good money habits and thus avoid the pitfalls of indebtedness. Aim to be debt-free.
Grace G McLean is a financial advisor and retirement specialist at BPM Financial Limited. Contact her at gmclean@bpmfinancial or visit the website: www.bpmfinancial.com. She is also a podcaster for Living Above Self. E-mail her at livingaboveself@gmail.com