Tackle your debt – Part 2: Stay debt-free
Read the first part of our Tackling Debt mini-series: Tackle your debts
So now you’re debt free, or at least have a very manageable debt load – good for you! With a little planning you can stay that way. Here are five questions to ask before your next purchase online using a credit card or applying for a loan.
- Do you really need the item, or is it an impulse purchase?
When it comes to managing your money, at MoneyWhizz, we advocate a simple, effective 50:30:20 rule when it comes to Needs, Wants and Saving. 50% of take-home pay should be allocated for essential life Needs, including housing, heat, food, transport and so forth. 30% to Wants and here we support some little life luxuries that make working to earn income worth the effort. For example, this can include some annual holidays, time away, little treats and maybe, a higher specification car. So long as all your income is not spent as an ‘emotional display of personal wealth’ then a little splashing out is OK. Finally, on the savings, we recommend allocating 20% of take-home pay to putting money aside each and every month. On this point, pensions are savings so if you participate in a workplace pension plan, count this into the the overall 20%…but also remember to build a ‘rainy-day’ fund too as you never know when little financial emergencies happen.
- Are you sure you can really afford it?
Nothing in life is certain and there are a number of ‘life events’ that can happen. Those include loss of income as a result of personal and employer situations. Loss of health and finally, a relationship breakdown. So, that income you have today may not be there in 6 or 12 months time so think about how you might be able to afford an item if your income was cut in half…or more!
- Will it improve your financial future?
There is good debt and bad debt. Good debt allows one to get a job where they borrow to buy a car to get them to and from work (if they have little access to public transport). Bad debt on the other hand can include ‘emotional’ spending. This can include debt on a credit card for gambling or too much “good-time” spending. The best kind of debt will improve your future. You can think of this a number of ways; buying a home (which may also appreciate in value), when it has the potential to generate income (such as starting a business) or improve future prospects (such as a student loan to help you get an education).
- Will you save more on the sale price than you’ll spend on interest charges?
Sales can trigger our emotional spending urges. What looks like a great deal on face value of a particular clothing item can cost a lot more in interest charges if we use credit cards to pay for them. Here is the deal. You buy and item for €500 and pay for it online using a credit card. So when the credit card bill arrives, you make the required ‘minimum payment’. It’s so low; it makes buying so cost effective, right! Wrong! Here is why; without getting into all of the complex compound maths, if you repay that €500 bill with the minimum payment, the item can cost almost as much in interest charges over time. Yes, €500 becomes €1,000! The rule here is work out the total cost of a purchase, including the interest cost over time if you are serious about managing your money.
- Should you use your savings or take a loan?
This depends. In this case, I would urge you to work out the total costs where you might be using debt. Because so little interest is paid in 2019 on savings (mostly it’s just .25% or a quarter of 1%), in many cases, if you have savings earning no income and the purchase amount is say less than €1,000, then pay for the item with cash. Remember to keep a little money for that ‘rainy-day’ fund but beyond that, why keep money on deposit earning next to nothing while paying a small fortune on credit card debt?
Frank Conway is a Qualified Financial Adviser and Founder of MoneyWhizz.org, the financial literacy initiative. MoneyWhizz financial well-being seminars are available at many leading employers as part of Employee Assistance Programmes.