Liz Koh: Don't let bad debt take over your life
OPINION: Debt. It is one of those four-letter words that conjures up a lot of emotion and negative images.
Admitting you have debt ranks alongside telling someone you have an embarrassing contagious disease on a scale of things you would rather not do. For that reason, people don't like talking about it.
Recent research in the UK by the Government-funded Money Advice Service found that one in six adults are at risk of crisis debt, but only 20 per cent of those people seek help. While this research was not done in New Zealand, it is not unreasonable to think that there could be similar findings here.
It is no surprise then, that debt is the focus for this year's Sorted Money Week. This kicks off on August 14 with the release of findings of a survey into debt and attitudes towards borrowing undertaken by the Commission for Financial Capability.
Debt problems can arise in two ways; firstly from some kind of life crisis such as loss of a job, illness, relationship breakdown or business failure, or secondly over a long period of time due to spending being more than income.
Debt can cause people to become anxious, withdrawn or depressed. It can lead to loss of sleep, relationship problems and health issues.
Sadly, children can be badly affected by debt. Growing up in a family under constant financial pressure is not a pleasant experience. Children can feel or be made to feel responsible for their parents' financial situation. They can suffer loss of self-esteem, isolation or even bullying at school because of missing out on school trips or social events, or having inadequate food or clothing.
Debt resulting from a life crisis can come about very suddenly. It can be made worse by a failure to adapt quickly enough to a change in financial circumstances. The impact of a life crisis can be lessened by having funds on hand to cover emergencies, and by quick action to recalculate budgets or sell assets so as to keep debt to a minimum.
Sometimes this can be mean hard decisions, such as accepting a much lower standard of living or selling the family home to buy a cheaper one. A quick reaction to a crisis helps bring stability and a quicker recovery.
When debt builds up slowly it is usually because of a long-term problem with balancing income and expenses. This is difficult to remedy if income is too low, but often it is because spending is not managed well. For around 10 per cent of the population, spending is an addiction, triggered by emotional or behavioural problems.
In these cases, the spending won't stop until the underlying causes are dealt with. Bad money habits, such as buying things you don't need, being tempted by retailers, or simply not getting around to paying bills on time can also see debt build up.
It goes without saying that if you are struggling with debt, you shouldn't take on more. Debt needs to be confronted head-on. Make a list of all debts, ranked in order by the interest rate charged. It might be possible to consolidate debt and refinance it a lower interest rate, for example by adding to your mortgage.
Careful budgeting is needed to keep spending lower than income and allow additional debt repayments to be made, starting with the debt with the highest interest rate. If your debt repayments are unmanageable, you will need to contact your creditors to make arrangements for a repayment plan.
Of course, not all debt is bad. Debt enables us to pay for an education, buy a home, set up a business or buy an investment property. Good debt is borrowing to buy something that produces a long lasting return. For education, it is the expectation of higher future income; for a business it is profit; for property it is capital gain and rental income. Good debt has the potential to significantly increase your wealth over time.
Debt is very much part of our daily lives but it needs to be managed. Good management is about knowing the difference between good debt and bad debt, getting rid of bad debt and using good debt to advantage. Debt is something that needs to be talked about more.
Keep a watchful eye for signs that someone you know is struggling with debt and offer a helping hand. Research from the Money Advice Service shows that within three months of receiving debt advice, two thirds of people are either repaying their debts or have already paid them.
They also report that they are less stressed, sleeping better and feeling physically better. Help with debt makes a huge difference to people's lives.
* Liz Koh is an authorised financial adviser and author of Your Money Personality; Unlock the Secret to a Rich and Happy Life, Awa Press. The advice given here is general and does not constitute specific advice to any person. A disclosure statement can be obtained free of charge by calling 0800 273 847.