Borrowing allows you to make purchases today, which will be repaid with future income. This means the decisions you make today have an impact on you in the future. By understanding the cost of borrowing and making conscious decisions about borrowing you can manage your finances effectively.
Borrowing, when used well, can be an effective financial tool; it can help finance your education, the purchase of a car, the start-up of a business, the purchase of a home. If managed poorly though, borrowing can lead to serious financial difficulty.
When you borrow you enter into a contractual agreement. The borrower receives something of value now and agrees to pay it off in the future, usually with interest. Interest is the cost of borrowing. This means that it costs more to buy something using borrowed money than it does with money you’ve saved up. Debt is the amount of money owed.
If you want to know more about borrowing, start with these:
Did You Know?
When you use a credit card, you are borrowing money. The average Australian credit card holder is paying around $700 in interest per year. Source: ASIC credit card debt clock January 2016
Good debt vs bad debt
It’s likely that some time you will consider taking out a loan. If you can purchase without borrowing, say by using existing savings, or delaying your expenditure, you can avoid the fees and charges associated with a loan.
When making decisions about borrowing it is important to know the difference between good and bad debt.
- Is an investment in your future
- Has a clear reason for taking it out
- Has a realistic plan for paying it back
- Uses the cheapest way of borrowing money (including all fees and charges)
- Eats into future wealth
- Is unaffordable – you cannot meet the monthly repayments
- Is used for purchases of items that are beyond your means
- Includes borrowing money to pay monthly bills
Thinking about borrowing?
Some useful things to think about when considering borrowing money are:
- What is the purpose of the loan:
- Do you need to spend the money now?
- Why are you choosing to borrow?
- Could your savings cover the purchase?
- Are there alternatives for your planned purchase?
- Could you find an affordable alternative such as a second hand item?
- What would be the relative advantages and disadvantages for you?
- What is the true cost of the loan: (online calculators are available)
- What is the interest rate for borrowing?
- What are the fees?
- Are the repayments affordable for you now? In the future? (Think about your current and expected earnings)
- Do you qualify for a No Interest Loan? The No Interest Loan Scheme (NILS) provides individuals and families on low incomes with access to safe, fair and affordable credit.
- Know who and what you are dealing with:
- Who is the lender?
- What is in the contract?
- What answers would you get if you ask these questions about your current loan(s)?
You can borrow from a range of banks and financial institutions. To take out a loan you need to provide identification to prove that you are who you say you are. When choosing a loan type and lender, you should be aware of all of the loan’s features and compare across lenders to make sure you are getting the loan that best suits your needs.
Loan features include:
- Interest rate for the loan – is the rate fixed for the life of the loan or can the lender change it?
- Fees and charges associated with the loan – establishment fees are common
- Penalties for early/late repayment
- Size of the loan
- Length of the loan (the number of months or years)
- Amount of the repayments
- Reputation of the lender
- What you can afford to repay, given your existing financial commitments.
Some people use their family and/or friends as a source of loans. For larger amounts, you could consider entering into a formal agreement that covers the details of the loan, how and when the loan will be repaid and the consequences of non-repayment.
Fixed rate loan
means the interest rate stays the same for the entire length of the loan
Variable rate loan
means the interest rate can fluctuate over the life of the loan
combines the actual interest rate with any foreseeable fees and charges, to give you a more accurate cost of the loan.
is how much the cost of living increases each year. It is measured by calculating the change in the cost of average living expenses (rent, groceries, child care, etc) from one year to the next
Types of debt
This segment covers a broad range of debt types and includes activities relating to different debt types. Later in the topic, activities allow you to investigate the types of loans that are relevant to you.
There are different kinds of debt, and the cost can vary significantly.
- Credit cards are used for their convenience and flexibility but are an expensive method of borrowing.
- Personal loans can be a cheaper alternative to credit card debt, but the interest rates are still high
- HECS-HELP used for undergraduate degrees has a low effective rate of interest
- Payday loans have very high interest rates.
- Car loans and mortgages are provided by many lenders and shopping around for the best deal can save money.
All loans have fees and charges – if you know what they are, you can choose to borrow at the lowest cost.
Dive Deeper into credit cards
Credit cards have a range of features, fees and charges. By being aware of them all, you can choose the credit card or loan that best suits your needs.
- Annual fees
- Interest rate charges
- Interest free period
- Reward schemes
- Other fees or bonuses.
Dive deeper into car and home loans
Car and home loans typically have:
- An interest rate
- An establishment fee
- Conditions associated with early repayments
- Statement fees
- Conditions associated with moving your loan to another lender
- Other fees and charges.
Dive deeper in to HECS - HELP loans
HECS-HELP is a loan to finance university education. As of 2016, there is no interest charged on the loan, but the value of the debt goes up by the annual inflation rate each year. Loan repayments only begin once the (former) student is earning above a threshold amount.
A HECS-HELP loan has features of good debt:
- Specific reason for the loan
- Education is an investment in your future
- Realistic loan repayment plan
- Low effective rate of interest
However, students can graduate with loans of more than $30,000 that have to be repaid. For double degrees and five-year plus degrees the amount may be even greater.
This can be a challenge when there are other bills to pay. Even though this loan looks like good debt, planning and budgeting are needed to ensure repayment is achieved.
There are a range of other assistance plans for financing tertiary study. A reliable source of information is the Australian Government’s Study Assist website
Dive deeper into payday loans
Payday loans are loans for amounts up to $2,000 that must be repaid between 16 days and 1 year. They are a very expensive form of borrowing and are often used by someone in financial difficulty.
Some more affordable alternatives include:
- Negotiate with your utility provider
- Find out if you’re eligible for a low interest loan
- Ask for an advance on your Centrelink benefits
Interest free deals
Deal or no deal?
A well-known store offers its customers “50 months interest free” on furniture purchases. Does this sound like a good deal? On the face of it it does, but it depends on what is in the fine print.
- Some stores require you to acquire a credit card which has an establishment fee and monthly account fees
- If there is an outstanding balance at the end of the 50 months very high rates of interest get charged
There are a variety of products and ways that interest free periods are offered. The general principles are:
- Read the fine print
- Interest free does not mean cost free.
- Very high rates of interest are charged if the amount is not repaid within the interest free period
Did You Know?
Financial institutions must provide a Product Disclosure Statement (PDS) for all loans, which includes information about the loan’s key features, fees, commissions, benefits, risks and the complaint handling procedure. When buying financial products, it is important to always read the PDS so that you can make informed decisions and know your rights.
Recognising debt problems
A problem with debt can happen to anyone, often due to circumstances beyond your control.
Problems with debt arise when your current income and savings do not cover your required repayments and other expenses. There are a range of potential triggers for debt problems that can include:
- Ill health/disability
- Loss of job
- Moving house
- Easy access to credit
- Insufficient awareness of loan conditions
- Accidental damage
- Relationship breakdown
- Drug or alcohol dependency
- Problem gambling
When debt problems arise, it is essential to take action quickly and seek help.
Understanding of the consequences of debt can help you to appreciate the seriousness of debt problems.
Debt problems can affect:
- Your relationships with family and friends – you may avoid people due to shame, anger and/or embarrassment
- Your emotional, mental and physical wellbeing
- Your ability to take out loans in the future.
Financial problems are often not spoken about within society, so it can be difficult to recognise when debts are becoming a problem.
Did you know?
If your name is on the utility bill in a shared house, you are legally responsible for the payment of the bill.
Taking control of debts
Ignoring debt problems does not make them go away. In fact, ignoring debts means the problem will get bigger, not smaller. Taking action quickly and seeking help are important steps.
Having debt problems means that you will need to prioritise your debts.
- Consider the consequences of not meeting or managing each debt, rather than the amount of hassling you are getting about each debt
- You could give the highest priority to debts with the most serious consequences e.g. not paying your rent could leave you homeless
- You could prioritise debts with higher interest rates over those with lower interest rates.
Debt problem help
Sources of help for debt problems include:
- Talking to the lender – they may temporarily reduce your repayments
- Asking for help – financial counsellors are trained professionals who can help with solving debt problems
- Asking for help – National Debt Helpline 1800 007 007
- Free legal advice – you can access free legal advice relating to your debts through Community Legal Centres if you cannot afford a private solicitor
- ASIC’s MoneySmart website has more information on managing debts here: Managing debts
Dive Deeper - Credit history
A credit report contains information about your credit history. It may include information about applications for credit cards, late payments for utility bills (water, electricity, etc) and any loans you have taken out.
Lenders use the information in your credit report to decide whether to lend you money. They can work out whether you can afford to repay a loan and if you are likely to repay a loan, based on your credit history.
Find out more about accessing your credit history here: Office of the Australian Information Commissioner
Did You Know?
If your parent is a co-signatory to your credit card, any late payments can affect his/her credit record.
If your parent is a guarantor for your loan and you default on your repayments, your parent is responsible for repayment of your loan.
If you take out a loan with a friend or family member (that is, both of you sign the loan forms) then if your friend/family member stops repaying their share of the loan, you are responsible for all of the loan.