Everyone should perform a financial health check at least once a month, if not fortnightly.
The benefits are vast:
1) You can see what bills need to be paid, what you've paid, tally up any expenses if you track them and update accounting or financial management software if you use them
2) If you have a budget then you can see how your actual income and expenditure measures up against your budgeted ones
3) If you've got savings in high interest accounts, in term deposits or whatever, then you can have a quick hunt around to see if there are better rates on offer, negotiate for them with your existent bank or set up new accounts and transfer your funds into them
4) You can check to see if you've been meeting your liabilities and have been making payments against outstanding debts
5) If you've got funds in transactional accounts not earning any interest, then move them into a high interest account
6) If you've got debts or bills to pay, you can figure out how you're going to allocate your income to pay them, instead of waiting until the due date comes around and then panicking about how to pay them
Recently I just performed mine. It involves doing the following:
1) Checking the interest rates on my online saving accounts and ensuring that I'm receiving a competitive rate on my savings
2) Pay my bills, check for future bills that may be forthcoming, check my expenditure for the month, compare with previous month and if I can be bothered, compare with last years
3) Recurring bills such as insurances, checking to see other offers out there and requesting or changing to something more competitive if I can't get a better deal
3) Finding out the balance of my superannuation retirement funds, the balance of my HECS student debt, checking the market value of my portfolio of stocks (although the iphone Bloomberg app is fantastic for this - it will automatically update the prices whenever I'm on the WiFi)
4) Check the social events that are coming up and the gifts that I have to buy (birthdays, baby showers, special events) or give (most wedding gifts require money to be given as gift since most couples are already living together)
The results of my recent financial health check:
1) (good) Savings account were good, all up for 2011
2) (good) Interest and dividend incomes were good, also all up for 2011
3) (good) Stock portfolio was good (capital gains), up for 2011
4) (good) Superannuation retirement fund was good, also up for 2011
5) (good) Expenses for Jan/Feb 2011 was down from Jan/Feb 2010, which is good
6) (good) Investment loan liability balance for Feb 2011 is down from Feb 2010, which is good
7) (stable) My HECS student debt is pretty flat, have been contemplating making another lump sum payment in April. I had the plan to make an additional lump sum payment in April off my HECS / HELP debt to drop the balance to 30% (ie have 70% paid off)
8) (good) Net wealth balance is up comparing Feb 2010 versus Feb 2011, which is good
No Euro trip for 2011, bummer:
Unfortunately the Euro trip will have to be for 2012 instead. It turns out, I barely have any annual leave days left after burning through so many days in 2010. So as a result, the 2011 savings/funds will be utilised in four possible ways:
1) Lending some to my friend to buy the replacement car since it was my fault that we were in that region when the guy wrote off the car and the insurance payout is insufficient for buying a replacement
2) Spending some on a snow trip somewhere, either Australia or New Zealand
3) Buying the investment property or
4) Doing nothing and buying some(all) toys on my wish list
Note on Jan/Feb 2010 vs Jan/Feb 2011 - I had a lot of one off expenditures in Jan/Feb 2010 which I didn't fortunately have to incur for Jan/Feb 2011. Expenditures such as passport renewal, prepaying for tickets etc for our trip to Japan and Hong Kong, medical expenses. I got really gouged by medical expenses last year to the tune of $3,314 and wrote two post on medical bills:
* Navigating our health insurance
* Poor health can send you broke
Showing posts with label Student loans. Show all posts
Showing posts with label Student loans. Show all posts
Friday, February 18, 2011
Monday, November 8, 2010
Merry Christmas and here's your tax bill
My three liabilities at tax time
Tax time and the need to dig into your pile of papers, bills, receipts and payment summaries.
I've completed mine. And unfortunately I've ended up with a tax payable. Because I've got investment income from various sources and I don't pay tax instalments over the year, it means that my liabilities accrue until I lodge my annual tax return.
Preparing for my tax liabilities
For every gross dollar of investment income that I earn, I have to deduct a percentage for my tax, a percentage for my HELP/HECS loan (a student loan from the government from uni days) and 1% for Medicare Levy. So pretty much, out of each dollar of investment income, approximately 50 to 65 cents reaches my account after all deductions and liabilities are paid.
It'd be crazy if I spent each $1 of gross investment income without accounting for the fact that practically 50% will be payable to the government.
Why don't I pay off my HELP loan??
HELP debt is only indexed to inflation and my latest statement shows that they indexed my balance with a 1.8% inflation rate. 1.8% per annum, charged the end of the year. I don't even have to try hard to invest my savings to exceed that measly 1.8% rate. It's a super cheap loan!
Besides the compulsory amounts, I can decide how much I wish to dump into it as extra repayments.
As long as I can earn at least 3.6% gross and more elsewhere, there is no incentive to pay my loan off early. It's like the cheapest loan around, unfortunately for the government. They know this, which is why they have dangled a carrot to spark some enthusiasm for people to pay it off early. You get a 10% discount on the amount you pay off above and beyond the compulsory amount.
Eg: You pay off an extra $500 in April (just before they index the amount to inflation in May, getting double bang for your bucks). If your loan is $10,000 then it will decrease to $9,450, a total payment of $550 with the discount.
[the maths: 10,000 - (500*1.1)]
So if you decide not to pay it off early, you will suffer death from thousands of little cuts (to borrow a phrase). The compulsory amount you have to pay has no discount applicable.
Paying off HELP/HECS in lump sums
If you can't handle the thought of carrying your loan indefinitely, ensure that you make lump sum payments of $500 or greater so that you qualify for the 10% discount.
Using our previous example: A $10,000 HELP/HECS balance with a $499 payment in April will mean that your loan will decrease only by $499 to $9,501 Sadly, no 10% discount.
The balance of my HELP/HECS loan
Working with percentages. I started off with 100%, currently out of that original amount, 49% has been paid off. By the end of this year, 57% should be paid off. It's always nice when the balance tips into my favour. It means that the loan will be eroded a lot faster due to the inflation amount shrinking.
Some of my goals
I have a lot of goals - at the forefront would have to be dabbling in a joint business and acquiring some more investments plus planning a massive trip to Europe(who doesn't have a few goals of some sort?). All these have a higher ROI than paying my student loan off, even the trip to Europe ^_* (a pyschological ROI!)
In terms of this HELP/HECS loan of mine that drags on, by the end of April 2011, I aim to make another lump sum payment and get 70% paid off.
Again, it's hard working up enthusiasm to pay off such a cheap loan. Mortgage rates are about 7.8%, calculated daily and compounded monthly while margin lending rates for stocks are around 9%, compounded daily... comparing this to my HELP/HECS loan being indexed annually at 1.8% ...soooo cheap!!
But alas, it has to be paid off eventually and rather than suffer death by a thousand cuts, I don't mind making lump sum payments every year and also qualify for the 10% discount.
If you've got a range of competing goals or loans/debts to pay, it really helps to sit down and calculate the interest on each of the liabilities so that you can sort out your priorities. Dave Ramsey's got the 'debt snowball' trend happening, which is pay off your smallest loan first, but technically, you're better off paying off the loan incurring the highest interest charge first.
Pyschologically, paying off the smallest loans first helps with clearing the headache of having multiple loans outstanding. It's also a source of motivation for some when they start to see some debts being paid off completely.
- Tax payable
- Medicare Levy payable
- HELP/HECS loan, adjustable depending on income, early repayment possible
Tax time and the need to dig into your pile of papers, bills, receipts and payment summaries.
I've completed mine. And unfortunately I've ended up with a tax payable. Because I've got investment income from various sources and I don't pay tax instalments over the year, it means that my liabilities accrue until I lodge my annual tax return.
Preparing for my tax liabilities
For every gross dollar of investment income that I earn, I have to deduct a percentage for my tax, a percentage for my HELP/HECS loan (a student loan from the government from uni days) and 1% for Medicare Levy. So pretty much, out of each dollar of investment income, approximately 50 to 65 cents reaches my account after all deductions and liabilities are paid.
It'd be crazy if I spent each $1 of gross investment income without accounting for the fact that practically 50% will be payable to the government.
Why don't I pay off my HELP loan??
HELP debt is only indexed to inflation and my latest statement shows that they indexed my balance with a 1.8% inflation rate. 1.8% per annum, charged the end of the year. I don't even have to try hard to invest my savings to exceed that measly 1.8% rate. It's a super cheap loan!
Besides the compulsory amounts, I can decide how much I wish to dump into it as extra repayments.
As long as I can earn at least 3.6% gross and more elsewhere, there is no incentive to pay my loan off early. It's like the cheapest loan around, unfortunately for the government. They know this, which is why they have dangled a carrot to spark some enthusiasm for people to pay it off early. You get a 10% discount on the amount you pay off above and beyond the compulsory amount.
Eg: You pay off an extra $500 in April (just before they index the amount to inflation in May, getting double bang for your bucks). If your loan is $10,000 then it will decrease to $9,450, a total payment of $550 with the discount.
[the maths: 10,000 - (500*1.1)]
So if you decide not to pay it off early, you will suffer death from thousands of little cuts (to borrow a phrase). The compulsory amount you have to pay has no discount applicable.
Paying off HELP/HECS in lump sums
If you can't handle the thought of carrying your loan indefinitely, ensure that you make lump sum payments of $500 or greater so that you qualify for the 10% discount.
Using our previous example: A $10,000 HELP/HECS balance with a $499 payment in April will mean that your loan will decrease only by $499 to $9,501 Sadly, no 10% discount.
The balance of my HELP/HECS loan
Working with percentages. I started off with 100%, currently out of that original amount, 49% has been paid off. By the end of this year, 57% should be paid off. It's always nice when the balance tips into my favour. It means that the loan will be eroded a lot faster due to the inflation amount shrinking.
Some of my goals
I have a lot of goals - at the forefront would have to be dabbling in a joint business and acquiring some more investments plus planning a massive trip to Europe(who doesn't have a few goals of some sort?). All these have a higher ROI than paying my student loan off, even the trip to Europe ^_* (a pyschological ROI!)
In terms of this HELP/HECS loan of mine that drags on, by the end of April 2011, I aim to make another lump sum payment and get 70% paid off.
Again, it's hard working up enthusiasm to pay off such a cheap loan. Mortgage rates are about 7.8%, calculated daily and compounded monthly while margin lending rates for stocks are around 9%, compounded daily... comparing this to my HELP/HECS loan being indexed annually at 1.8% ...soooo cheap!!
But alas, it has to be paid off eventually and rather than suffer death by a thousand cuts, I don't mind making lump sum payments every year and also qualify for the 10% discount.
If you've got a range of competing goals or loans/debts to pay, it really helps to sit down and calculate the interest on each of the liabilities so that you can sort out your priorities. Dave Ramsey's got the 'debt snowball' trend happening, which is pay off your smallest loan first, but technically, you're better off paying off the loan incurring the highest interest charge first.
Pyschologically, paying off the smallest loans first helps with clearing the headache of having multiple loans outstanding. It's also a source of motivation for some when they start to see some debts being paid off completely.
Friday, October 23, 2009
Extreme Frugality Sucks
Being too frugal will make you miserable.
I've been reading hundreds of blogs lately. It's like my new addiction. I've noticed a few recurring themes now when it concerns financial blogs. The blogs with massive subscribers are either a) Informative, interesting and useful or b) Not so informative, but the blogger's story and background is dramatic and harrowing ... such as "This blog is about my journey in paying off my $159,000 debt."
The blogs that I choose to subscribe to would be the informative and interesting one. Is it really beneficial to read about someone who racked up over $100,000 in stupid credit card debt and heavy bouts of consumption binge? Sure, it's gripping and interesting, but you are really wasting your time unless you're in the same situation and trying to pay off the same silly consumption debt.
I have never had any consumption debt. Have never wanted to follow the crowd and buy a gazillion number of shoes and Louis Vuitton handbags. The sheer crowd of females in the city carrying LV bags proudly... there are so many of them that it's almost like an Louis Vuitton Brown Bag Army Brigade. I love good quality bags or shoes and pretty things just like any typical female but I just will not buy an LV Bag that will lump me into that category.
I have one credit card. If I need larger credit, I contact the bank to have the limit increased. It's so pointless to parade around with 5 or 15 credit cards. I have some investment debt. A positive net worth. A bit of student debt left to pay off which I don't choose to pay off with a lump sum payment because it's indexed to inflation and I can earn a better return elsewhere.
I hesitate at taking or reading financial advice from anyone and any blogger who has racked up consumption debt.
Would you consult an acoholic about how to quit drinking when they are still drinking heavily?
In order to progress and develop your skills in finance and investing, you need to take a good look inside yourself. You need to focus more on earning passive income than trying to learn how to be super frugal.
The bloggers with massive consumer debt, they will blog about selling things on ebay, craigslist, how to save money here and there and how to be so frugal that you live your life miserably. If you have debt, then yes, it's probably a good guidance for you.
But if you have savings and a positive net worth, your time is better spent reading websites and blogs where the bloggers have a positive net worth as well. That way you can learn more about how to invest, the type of assets you can invest in, how to calculate returns, the terminology and the financial geek speak etc.
But things like, never eating out, always cooking your own food from scratch, spending all your weekends cutting out coupons to save $3 or $5, growing your own vegetables, driving all over town to find discounts and bargains, signing up for 15 credit cards that have 0% introductory interest just so you can arbitrage and place it into a bank account and earn 3-4% interest and all those time consuming activities.
Is your time more valuable if you used it on productive matters such as starting your own business, improving your professional skills and working on increasing your income via a better paying job or improving your investing skills so that you can grow your passive income?
Extreme frugality is not the road to riches. It's the road to feeling miserable and cantankerous. Spend in moderation and focus on reading materials that will improve your business, professional or investment skills and you will discover what I've discovered... the bliss of earning income passively from investments and multiple income streams.
I've been reading hundreds of blogs lately. It's like my new addiction. I've noticed a few recurring themes now when it concerns financial blogs. The blogs with massive subscribers are either a) Informative, interesting and useful or b) Not so informative, but the blogger's story and background is dramatic and harrowing ... such as "This blog is about my journey in paying off my $159,000 debt."
The blogs that I choose to subscribe to would be the informative and interesting one. Is it really beneficial to read about someone who racked up over $100,000 in stupid credit card debt and heavy bouts of consumption binge? Sure, it's gripping and interesting, but you are really wasting your time unless you're in the same situation and trying to pay off the same silly consumption debt.
I have never had any consumption debt. Have never wanted to follow the crowd and buy a gazillion number of shoes and Louis Vuitton handbags. The sheer crowd of females in the city carrying LV bags proudly... there are so many of them that it's almost like an Louis Vuitton Brown Bag Army Brigade. I love good quality bags or shoes and pretty things just like any typical female but I just will not buy an LV Bag that will lump me into that category.
I have one credit card. If I need larger credit, I contact the bank to have the limit increased. It's so pointless to parade around with 5 or 15 credit cards. I have some investment debt. A positive net worth. A bit of student debt left to pay off which I don't choose to pay off with a lump sum payment because it's indexed to inflation and I can earn a better return elsewhere.
I hesitate at taking or reading financial advice from anyone and any blogger who has racked up consumption debt.
Would you consult an acoholic about how to quit drinking when they are still drinking heavily?
In order to progress and develop your skills in finance and investing, you need to take a good look inside yourself. You need to focus more on earning passive income than trying to learn how to be super frugal.
The bloggers with massive consumer debt, they will blog about selling things on ebay, craigslist, how to save money here and there and how to be so frugal that you live your life miserably. If you have debt, then yes, it's probably a good guidance for you.
But if you have savings and a positive net worth, your time is better spent reading websites and blogs where the bloggers have a positive net worth as well. That way you can learn more about how to invest, the type of assets you can invest in, how to calculate returns, the terminology and the financial geek speak etc.
But things like, never eating out, always cooking your own food from scratch, spending all your weekends cutting out coupons to save $3 or $5, growing your own vegetables, driving all over town to find discounts and bargains, signing up for 15 credit cards that have 0% introductory interest just so you can arbitrage and place it into a bank account and earn 3-4% interest and all those time consuming activities.
Is your time more valuable if you used it on productive matters such as starting your own business, improving your professional skills and working on increasing your income via a better paying job or improving your investing skills so that you can grow your passive income?
Extreme frugality is not the road to riches. It's the road to feeling miserable and cantankerous. Spend in moderation and focus on reading materials that will improve your business, professional or investment skills and you will discover what I've discovered... the bliss of earning income passively from investments and multiple income streams.
Thursday, October 22, 2009
Understanding loans and their features
Loans can have a fixed or variable rate of interest, be secured or unsecured, negotiable interest rates and payment terms. There are many different types of loan available.
Fixed or Variable Interest
1) Fixed Interest – Interest is fixed for the duration of the loan, from the time it’s taken out to the day you pay it off.
2) Variable Interest- The rate changes either up or down depending on the market rate (which varies depending on the loan type eg: LIBOR, Bond, Central Bank rates).
Secured or Unsecured
1) Secured – Then lender can sell whatever asset you’ve secured the loan against if you default and can’t pay the loan. Assets typically used as security are houses, cars, stock portfolios and personal possessions. Loans that are usually secured are car loans, mortgages, mortgage line of credit accounts
2) Unsecured- The lender has no recourse. You’ve got not asset with the lender as a collateral. If you default on the loan, the lender considers you a bad debt and will most likely pass you along to the debt collection agency as a last resort. This loan is riskier for lenders so they usually charge a higher interest rate because of this increased risk. Examples of unsecured loans are credit cards, store cards, personal loans and personal lines of credit
The different type of loans available are:
Car Loans
Car loans are usually secured against your vehicle. They may insist on car insurance as well. You should shop around for the best financing deal first before going shopping for a car because car yards will always have their own financing but this may not be the best deal around.
Car loans are usually for a fixed amount of money, organised upfront with a fixed interest rate, repayment amount and period. Example: $10,000 car loan at 10% interest, repayable by monthly instalments for the duration of 4 years.
Credit Cards
If you can’t pay off a credit card every month before the interest free period ends, then don’t use a credit card. If you don’t listen to this wise and sagacious advice, then it will ultimately be your downfall. You only need one or at the most two credit cards ever at any period of time.
These beasts come in various structures with interest free period ranging from 0 days or 55 days to 6 months typically. Read the fine print! Understand what you are signing up for. Don’t be fooled into thinking that it’s worth spending on the credit card because you get reward points or frequent flyer points. Wow, you’ve gone and spent $3,500 so that you can collect 3500 points, the equivalent of $25-$30 in rewards – if you can't pay that $3,500 off before incurring interest charges then it's a bargain with the devil.
If you can’t pay them off by the interest free period, you will be paying through the roof with rates ranging from 11% to a more typical rate such as 18% and 28% per annum interest. Usually the banks will have a 'minimum payment' amount of around $25 or $30. The problem with paying only the minimum amount is that you will end up paying interest on the balance owing and it will take you 25-40 years to pay off the credit card at the minimum amount that they request you to pay.
I will re-iterate myself because credit cards have been at the root of marital breakdowns, stress, tears and bankruptcies – if you can’t pay them off by the interest free period, don’t use them. Otherwise, you are best off looking at other financing options such as lines of credits or personal loans which charge lower rates of interest.
Debt Consolidation Loans
Debt consolidation is a process whereby you take out a new loan (or increase an existing loan) in order to close off several smaller, separate loans. This can be done by organising a new personal loan, refinancing your mortgage and rolling those debts into your mortgage or withdrawing equity out to pay off your multiple loans.
Why do people consolidate their debts? They consolidate in order to close off the loans with a higher interest rates onto a new loan with a lower interest rate. Credit card debts may be incurring interest at anything between 9% - 38% and by consolidating and refinancing, you replace the debt with a new debt with a lower rate such as 9%. It's also sometimes done to simplify repayments, instead of multiple payments to multiple loans, you make just one single payment for that new consolidated loan.
Margin Loans
Loans that are taken out usually to buy stocks and invest in portfolios. It can also be utilised when trading CFDs. The margin loan is usually secured by your stock portfolio and they will have different loan to valuation ratios (LVR) depending on what stock you buy. The average LVR could be up to a maximum of 70-80%, this varies depending on the lending institution but the higher the LVR, the more you expose yourself to margin calls.
I'll be writing a separate article regarding margin loans due to it's complexity and how it operates.
Mortgage Loans
Mortgage loans are used to buy residential and commercial properties. It's usually for an established amount (eg $380,000) with either a variable or fixed interest rate. Your loan contract will determine the period of the loan (eg: 25 years, 30 years or 40 years) and the monthly repayment amount, which may vary depending on the interest rate charged.
I will be writing articles about how to pay your mortgage off faster, amortisation schedules and techniques to pay your mortgage off faster.
Mortgage offset and redraw facilities
A mortgage offset account works by offsetting your mortgage balance by the amount in your offset account. The interest that is charged is on the net balance amount between these two accounts. To illustrate, assume Sally's mortgage on the 1st of March is $380,000. If Sally has $100,000 in her offset account, then the bank will charge Sally interest on only $280,000.
Lending institutions will usually not approve your loan without a deposit however, they may lend anything from a maximum of 80% to 105% of the property's value depending on your income and repayment abilities. The smaller your deposit and the greater your LVR, you may have to pay lenders mortgage insurance on your loan.
A redraw facility may be a component of your mortgage, depending on whether your mortgage loan has this facility or not (check your mortgage contract). With a redraw facility, if you make any extra repayments then you can withdraw the extra repayment anytime you wish.
Again, this is a complex area and I will write a full article dedicated to mortgage loans. If you don't understand the complexity of a mortgage loan then you will not know what features of the mortgage that you will need. Also, do you really want to be spending the next 30 years of your life paying off your mortgage? Understanding the finer points will allow you to establish the appropriate loan for your circumstance and be flexible enough to cater for your repayment ability.
Overdraft
An overdraft is usually an extension of your normal account, allowing you to have a negative balance. Businesses commonly have overdraft enabled on their account to cater for cash flow imbalances throughout the year. Some individual accounts has overdraft facilities enabled, but be sure to check if you are being penalised for the usage of this facility everytime your account drops below a $0 balance.
Payday Loans
Payday loans are the biggest rort ever. This has got to be the very last resort! The moment you start using payday loans, you are probably closer to insolvency and bankruptcy than you realise. If I could say which loan to avoid at all cost, it would be this one.
Personal Loans
These loans are either secured or unsecured. If the loan is secured, the rate will usually be lower than credit card rates and loans that are unsecured. They usually have a fixed interest rate and a set amount established at the beginning of the loan. The loan will have a payment schedule with fixed repayments, normally monthly, until the loan is paid off. You cannot vary a personal loan without creating a brand new personal loan.
Commonly used for buying cars, consolidating various loans, purchasing white goods, renovation, holidays and multitude of things. Normally classified as a bad debt and not used for investing but for aiding personal spending.
Revolving Line of Credit / Line of Credit Accounts
Similar to an oversized credit card, except they are usually secured. There is an established limit such as $100,000 and you can spend from the line of credit as much and as often as you wish until you have spent your limit – which is $100,000 in this example.
Monthly payments are based only on the component that you’ve used and may vary from a certain percentage to interest only. So if you have a $100,000 line of credit (LOC) and you’ve spent $50,000 on renovation, then you will usually have to pay the interest or minimum percentage on only that $50,000 that you’ve spent. Don’t fool yourself though. You will have to pay that $50,000 principal debt eventually, so be wise and spend only what you can afford.
Store card loans and credit
This basically covers vendor financing. It's where a retail store will offer you their store credit card (eg David Jones or Macy etc). Depending on the terms and conditions, these credit varies markedly. Some whitegood stores selling furniture, for example, may offer a 'buy now, interest free for 2 years' type of deal. If you don't pay the balance off before the interest becomes applicable then they commonly back date the interest charge to the very first date that you bought the goods.
It can be a very expensive lesson to learn. Be wise and if you can't afford to pay for it today, then don't buy it.
Student Loans
These differ from country to country. I’ll only be covering Australian student loans. In Australia they’re called HELP or FSS debts. Which is Higher Education Loan Programme debts.
I'll be writing about HELP debts in depth in a separate article due to it's complexity regarding the discounts that are applicable depending on how you pay the HELP debt.
There are so many type of loans out there. Basically everything and anything could be financed nowadays by the stores or by the shops. The terms and conditions of each loan differs and repayment structures also differ. If you don't understand the loan, don't borrow until you've done your due diligence and understand what you are signing up for.
Fixed or Variable Interest
1) Fixed Interest – Interest is fixed for the duration of the loan, from the time it’s taken out to the day you pay it off.
2) Variable Interest- The rate changes either up or down depending on the market rate (which varies depending on the loan type eg: LIBOR, Bond, Central Bank rates).
Secured or Unsecured
1) Secured – Then lender can sell whatever asset you’ve secured the loan against if you default and can’t pay the loan. Assets typically used as security are houses, cars, stock portfolios and personal possessions. Loans that are usually secured are car loans, mortgages, mortgage line of credit accounts
2) Unsecured- The lender has no recourse. You’ve got not asset with the lender as a collateral. If you default on the loan, the lender considers you a bad debt and will most likely pass you along to the debt collection agency as a last resort. This loan is riskier for lenders so they usually charge a higher interest rate because of this increased risk. Examples of unsecured loans are credit cards, store cards, personal loans and personal lines of credit
The different type of loans available are:
Car Loans
Car loans are usually secured against your vehicle. They may insist on car insurance as well. You should shop around for the best financing deal first before going shopping for a car because car yards will always have their own financing but this may not be the best deal around.
Car loans are usually for a fixed amount of money, organised upfront with a fixed interest rate, repayment amount and period. Example: $10,000 car loan at 10% interest, repayable by monthly instalments for the duration of 4 years.
Credit Cards
If you can’t pay off a credit card every month before the interest free period ends, then don’t use a credit card. If you don’t listen to this wise and sagacious advice, then it will ultimately be your downfall. You only need one or at the most two credit cards ever at any period of time.
These beasts come in various structures with interest free period ranging from 0 days or 55 days to 6 months typically. Read the fine print! Understand what you are signing up for. Don’t be fooled into thinking that it’s worth spending on the credit card because you get reward points or frequent flyer points. Wow, you’ve gone and spent $3,500 so that you can collect 3500 points, the equivalent of $25-$30 in rewards – if you can't pay that $3,500 off before incurring interest charges then it's a bargain with the devil.
If you can’t pay them off by the interest free period, you will be paying through the roof with rates ranging from 11% to a more typical rate such as 18% and 28% per annum interest. Usually the banks will have a 'minimum payment' amount of around $25 or $30. The problem with paying only the minimum amount is that you will end up paying interest on the balance owing and it will take you 25-40 years to pay off the credit card at the minimum amount that they request you to pay.
I will re-iterate myself because credit cards have been at the root of marital breakdowns, stress, tears and bankruptcies – if you can’t pay them off by the interest free period, don’t use them. Otherwise, you are best off looking at other financing options such as lines of credits or personal loans which charge lower rates of interest.
Debt Consolidation Loans
Debt consolidation is a process whereby you take out a new loan (or increase an existing loan) in order to close off several smaller, separate loans. This can be done by organising a new personal loan, refinancing your mortgage and rolling those debts into your mortgage or withdrawing equity out to pay off your multiple loans.
Why do people consolidate their debts? They consolidate in order to close off the loans with a higher interest rates onto a new loan with a lower interest rate. Credit card debts may be incurring interest at anything between 9% - 38% and by consolidating and refinancing, you replace the debt with a new debt with a lower rate such as 9%. It's also sometimes done to simplify repayments, instead of multiple payments to multiple loans, you make just one single payment for that new consolidated loan.
Margin Loans
Loans that are taken out usually to buy stocks and invest in portfolios. It can also be utilised when trading CFDs. The margin loan is usually secured by your stock portfolio and they will have different loan to valuation ratios (LVR) depending on what stock you buy. The average LVR could be up to a maximum of 70-80%, this varies depending on the lending institution but the higher the LVR, the more you expose yourself to margin calls.
I'll be writing a separate article regarding margin loans due to it's complexity and how it operates.
Mortgage Loans
Mortgage loans are used to buy residential and commercial properties. It's usually for an established amount (eg $380,000) with either a variable or fixed interest rate. Your loan contract will determine the period of the loan (eg: 25 years, 30 years or 40 years) and the monthly repayment amount, which may vary depending on the interest rate charged.
I will be writing articles about how to pay your mortgage off faster, amortisation schedules and techniques to pay your mortgage off faster.
Mortgage offset and redraw facilities
A mortgage offset account works by offsetting your mortgage balance by the amount in your offset account. The interest that is charged is on the net balance amount between these two accounts. To illustrate, assume Sally's mortgage on the 1st of March is $380,000. If Sally has $100,000 in her offset account, then the bank will charge Sally interest on only $280,000.
Lending institutions will usually not approve your loan without a deposit however, they may lend anything from a maximum of 80% to 105% of the property's value depending on your income and repayment abilities. The smaller your deposit and the greater your LVR, you may have to pay lenders mortgage insurance on your loan.
A redraw facility may be a component of your mortgage, depending on whether your mortgage loan has this facility or not (check your mortgage contract). With a redraw facility, if you make any extra repayments then you can withdraw the extra repayment anytime you wish.
Again, this is a complex area and I will write a full article dedicated to mortgage loans. If you don't understand the complexity of a mortgage loan then you will not know what features of the mortgage that you will need. Also, do you really want to be spending the next 30 years of your life paying off your mortgage? Understanding the finer points will allow you to establish the appropriate loan for your circumstance and be flexible enough to cater for your repayment ability.
Overdraft
An overdraft is usually an extension of your normal account, allowing you to have a negative balance. Businesses commonly have overdraft enabled on their account to cater for cash flow imbalances throughout the year. Some individual accounts has overdraft facilities enabled, but be sure to check if you are being penalised for the usage of this facility everytime your account drops below a $0 balance.
Payday Loans
Payday loans are the biggest rort ever. This has got to be the very last resort! The moment you start using payday loans, you are probably closer to insolvency and bankruptcy than you realise. If I could say which loan to avoid at all cost, it would be this one.
Personal Loans
These loans are either secured or unsecured. If the loan is secured, the rate will usually be lower than credit card rates and loans that are unsecured. They usually have a fixed interest rate and a set amount established at the beginning of the loan. The loan will have a payment schedule with fixed repayments, normally monthly, until the loan is paid off. You cannot vary a personal loan without creating a brand new personal loan.
Commonly used for buying cars, consolidating various loans, purchasing white goods, renovation, holidays and multitude of things. Normally classified as a bad debt and not used for investing but for aiding personal spending.
Revolving Line of Credit / Line of Credit Accounts
Similar to an oversized credit card, except they are usually secured. There is an established limit such as $100,000 and you can spend from the line of credit as much and as often as you wish until you have spent your limit – which is $100,000 in this example.
Monthly payments are based only on the component that you’ve used and may vary from a certain percentage to interest only. So if you have a $100,000 line of credit (LOC) and you’ve spent $50,000 on renovation, then you will usually have to pay the interest or minimum percentage on only that $50,000 that you’ve spent. Don’t fool yourself though. You will have to pay that $50,000 principal debt eventually, so be wise and spend only what you can afford.
Store card loans and credit
This basically covers vendor financing. It's where a retail store will offer you their store credit card (eg David Jones or Macy etc). Depending on the terms and conditions, these credit varies markedly. Some whitegood stores selling furniture, for example, may offer a 'buy now, interest free for 2 years' type of deal. If you don't pay the balance off before the interest becomes applicable then they commonly back date the interest charge to the very first date that you bought the goods.
It can be a very expensive lesson to learn. Be wise and if you can't afford to pay for it today, then don't buy it.
Student Loans
These differ from country to country. I’ll only be covering Australian student loans. In Australia they’re called HELP or FSS debts. Which is Higher Education Loan Programme debts.
I'll be writing about HELP debts in depth in a separate article due to it's complexity regarding the discounts that are applicable depending on how you pay the HELP debt.
There are so many type of loans out there. Basically everything and anything could be financed nowadays by the stores or by the shops. The terms and conditions of each loan differs and repayment structures also differ. If you don't understand the loan, don't borrow until you've done your due diligence and understand what you are signing up for.
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