Should you make more than the minimum repayment on your debts?

Short answer: yes.
 
This raises a few questions:
  • Which debts should you pay first?
  • How much more should you pay?
  • What if you are having trouble finding any extra cash?
Let’s examine some possibilities.

 


Which debts should you pay first?

 
Short answer: the ‘bad’ ones.
 
[note: I use categories of good, bad and luxury when I’m describing debt. I also baulk at the traditional definitions of asset and liability. This causes consternation among finance and accounting professionals, but it works.]
 
‘Bad’ debt is for items that will not grow in value and pay you an income. They’re bad because you’re usually buying something that
  • declines in value (e.g. phones), and/or
  • takes cash to sustain (e.g. cars).
Because you’re paying interest, you’re paying more than the ticket price. Sometimes, you’re paying more – three or four times the original amount. It’s borrowing from your future in the worst way possible.
 
Common debts in this category are:
  • credit cards,
  • car loans,
  • personal loans, and
  • payday loans.
All other debts should still be paid off as quickly as you can, but these ‘bad’ debts should be prioritized.

‘What about my mortgage?’

 
This is definitely worth paying off quickly. A home loan is not as bad as ‘bad’ debt. But, it’s still paying interest for something that takes cash to sustain and won’t earn you an income. If you fail to pay off escalating bad debt, you could lose your home while liquidating or going bankrupt.
 

‘What about my ‘good’ debts?’

 
‘Good’ is a relative term in this case. The best kind of debt is no debt! ‘Good’ debt is for assets – things that will grow in value and pay you an income. The most common example of this kind of debt is an investment home loan.
 
But not all investment home loans are ‘good’. The property itself if very important here.
 
Bottom line: you still need to pay it off, but focus any extra efforts on your ‘bad’ and ‘luxury’ debts first.

How much more should you pay?

 
Short answer: as much as you can afford.
 
Every extra dollar you pay off your debt is one less dollar accruing interest that you’ll have to pay in the future. There is no amount too small here.
 
The big question is: what can you afford?
 
In the face of debt, I recommend giving your spending a good, hard look. This requires a level of honesty and scrutiny that can be uncomfortable, but it’s worth doing. Now is an excellent time to stop spending on anything beyond basic needs.
 
While you’re paying off your debt, it’s still a good idea to accrue some savings. I think of it as a buffer fund. These act as a cushion against shocks, e.g. you lose your job, or your car breaks down, or your kids get sick. Often it’s the absence of this buffer that lands people in debt in the first place. It would not be good to be paying down your debt, then having to increase your debt again in an emergency.
 

How big should your buffer fund be?

 
Anything is better than nothing. Two weeks of living costs will see you in a better financial position than half of your fellow citizens. In the long term, you can build this up as high as you like (I keep at least a year’s living costs in my buffer fund).


What if you’re having trouble finding anything extra?

 
Short answer: you can only do what you can do.
 
For those whose debt burdens are such that only the minimum repayment is possible, suggestions to pay extra can seem insulting. I have often heard:
 
“If I had extra, I’d pay it already!”
 
This is a natural response when you feel you’ve been doing all you can. Debt is stressful, and the last thing you need is someone teaching you to suck eggs.
 
Yet, as I said above: this requires a level of honesty and scrutiny that can be uncomfortable, but it’s worth doing properly. Treat the following examples as a checklist of options. Confirm you’ve done all you can and are comfortable with, then cut yourself some slack.
 

Examples: Finding extra cash

 
There are two ways to get more cash:
  1. Spend less.
  2. Earn more.
Make sure you look at both options.
 
If I was trying to reduce a bad debt, here is what I would in the first week, in this order:
  • Write a list of ways I could increase my income and do what make sense, for example:
    • working extra shifts,
    • asking boss for a pay rise (if warranted), or
    • looking for an additional or alternative, higher-paid job.
  • Cancel subscriptions that:
    • are not essential,
    • do not carry a penalty for cancelling, and
    • will mean I have more cash flow (e.g. cable TV, Foxtel, Netflix, magazines).
  • Negotiate cheaper alternatives to essential subscriptions wherever possible. I would ensure I keep as much functionality and coverage as I need (e.g. power, gas, insurance, phone, internet).
  • Cancel leisure activities that I can get refunds for. E.g. upcoming holidays, movie/theatre/concert tickets. I would also look at selling the tickets at or above cost price if demand is enough.
  • Cancel upcoming plans to spend money that is not essential (e.g. going out to dinner).
  • Shop for perishable items in smaller amounts, more regularly if needed. This escapes the false sense of economy we get when buying in bulk then throwing them out when they spoil.
  • Work out the cheapest way to travel, and do it. E.g. determine whether petrol and parking cost is more/less than public transport or riding a bicycle.
  • Stop buying clothes. Make what I have last, and if I need more, borrow from friends/family or get them from the op shop.
I would also consider what I own that I could sell to get a chunk of cash. For example if my family had two cars, I’d look to sell one. This has to pass a common-sense test. No point selling your TV, only to have to buy it back on credit for 10x what you got six months later because you need it for your lifestyle.
 
To keep a modicum of happiness, I would do what I could to still have fun, for example:
  • borrow books and/or DVDs from the library,
  • visit a toy library to get ‘new’ toys for the kids,
  • make a special dinner at home in lieu of going out,
  • have picnics in the park instead of going to concerts,
  • search for discount vouchers and coupons to do something special occasionally at as low a price as I can.

What about the kids?

 
We often worry about what cutting back will do to our kids. We think they’ll feel deprived if we no longer go out to dinner every Friday, or go on a skiing holiday to Europe, or if we don’t bring them a new toy each week, or if they miss out on that new phone that their friends have.
 
I can only share my personal experience here.
 
I grew up with very little money around. We had a one-week holiday each year to a place one hour’s drive away and we all shared one room. Our car was old, our house was a bit scruffy, and I wore my clothes and shoes till they had to be replaced.
 
I had no idea we were poor until I won a scholarship to a prestigious girls’ school. There, I met people with a lot more money and realised we didn’t have much.
 
I was oblivious to our financial state because I was safe and loved. If your kids are safe and loved, odds are they will be too.

I’ve done all this. Now what?

 
If you have diligently done all you can, then that’s it – you have done all you can. I hope in that case that this has reassured you. Time to cut yourself some slack.
 
If you’ve done all you can and you’re still drowning, it’s time to get some help. Financial counseling would be a good place to start. Google your local provider. In Western Australia, where I am based, Consumer Credit Legal Service WA is a good place to start.

Want more detail on debt?

 
We offer a free online course about debt. It covers:
  • how debt works,
  • why types of debt exist,
  • why you might want debt, and why lenders want you to have it,
  • how to get out of debt fast, and
  • how to stay out of debt.
Anyone with computer access can enroll through our website or via Udemy and join our 1,600+ students. We welcome all comers.

 
Lacey Filipich is the co-founder and director of Money School. She helps parents raise financially savvy kids and adults get on top of their finances. Connect with her on LinkedIn and follow the Money School Facebook page to learn more.
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