Debt-buster Solution Is Hardly Magic
Sun Herald
Sunday August 29, 2004
ISN'T it heart-warming how generous banks are these days? They regularly offer to dramatically increase our credit card limits and give us big personal loans, and they make it oh-so-easy to use the equity in our homes as a slush fund.
Actually, there's nothing heart-warming about it. The more we borrow, the more they earn. And the longer we are in debt. Regardless, our desire for instant gratification sees that we take up many of the banks' offers so many that the Reserve Bank of Australia says we now collectively owe three times what we did a mere 10 years ago: $691 billion.Almost daily, I get emails from people desperate to break the debt cycle but who don't know where to turn.In the words of one reader: "I'd really love some professional help and have sought it, but just can't afford to pay for the 'plans' that are offered by some financial institutions. Unless, of course, they can take our American Express!"The plans to which he is referring are marketed by specialist debt reduction companies and some mortgage brokers one industry creates a problem, another springs up to solve it and offer a "magic" solution to debt.The basic premise is to use your salary to reduce your mortgage interest.First, these companies restructure your mortgage into a line of credit. Next, they tell you to direct your salary into it. And, finally, they instruct you to put all your living expenses on a credit card (with a long interest-free period) and move the money out of your mortgage only when the monthly bill is due.What do they charge you for this? Up to $6000 (you could also face refinancing costs and, possibly, penalties for breaking your existing loan).What do you stand to gain?A whole lot less than that.In fact, our report on the facing page shows that a person with a $250,000 loan and a $1500 salary would save just over $4000 with this strategy. Worse still, they would make more than $2000 of that saving if they didn't even bother with the credit card bit.Putting it another way: you are very likely to outlay more up front than you stand to gain over 25 years!Hardly the point of debt reduction.But there is another element to all of this. If you are incapable of resisting an impulse buy, a trait common to people whose debts are out of control, the very last thing you should be doing is taking out a line of credit. It makes it far too easy to take your loan right back up to where it started from and beyond.The bank won't complain.But neither, by the way, will the debt reduction company because it probably earns trailing commission on your outstanding balance. (Anyone say conflict of interest?)These companies have all sorts of fancy graphs and computer programs designed to convince you that their services will save you a fortune.They won't admit it, but all these really show is the impact of making extra repayments something you could do free of charge with a plain vanilla, low-cost mortgage.The only sure-fire way to reduce debt is to limit your spending so you can afford extra repayments. The story on page 8 Spring clean your finances will show you how.
© 2004 Sun Herald