Don't
overlook revolving credit as a risk to wealth
The credit card might not be the only major cause of the rapid increase
in consumer debt. Lately, consumer debt counsellors have been seeing
more problems relating to a loan called a revolving line of credit.
Sue Mahalingham, principal solicitor with the Consumer Credit Legal
Service, says widespread problems with mortgages are a relatively
new phenomenon.
"Three years ago, 5 percent of problems we helped were related to
mortgage type products," she said.
"This has increased to around 20 percent and nearly two thirds of
that would have to be related to revolving lines of credit."
These loans operate differently to the traditional style of mortgage,
where the principal and interest is paid off over a specified time.
Traditional mortgages see a regular payment amount, including a component
of interest and principal, in each regular instalment. Lines of credit
often have no set payment, other than an obligation to meet the interest
component on a monthly basis. With some varieties, there is no need
to make any principal payments and the line of credit effectively
becomes a "super overdraft", with a limit up to 80 % of the value
of the borrower's home.
According to promoters, passing salaries and other income through
the same account sees the average daily balance, used to calculate
the interest amount, being less than with a traditional mortgage.
As the interest cost is lower, more goes towards the repayment of
the loan and this hopefully reduces the term of the loan.
"The problem here is that usually, the interest rate is higher than
with a traditional loan," Ms Mahalingham said.
"Unless you really understand the only way to get ahead is to keep
as much as you can in the account for as long as you can, you might
actually be worse off."
Other problems relate to the consolidation of multiple loans into
one single line of credit. In this case, people with cash-flow problems
might see the reduced loan payment, based on interest only, as solving
their problems. In many cases, consumers are effectively continuing
to pay for a purchase long after the item was bought. Easy credit
access for those who may already have difficulty in controlling their
spending is another area of concern.
The pre-approved "gold credit card", with a credit limit up to 80%
of the value of the house, has seen some actually increase their borrowing's
once the facility has been established. Critics blame advertising
and the failure to properly explain how lines of credit operate as
reasons why some borrowers are worse off. Consumers are further confused
when a mixture of loans, including revolving lines of credit, fixed
interest and traditional loans, are presented as a bundled package
of debt solutions. Monthly statements provided by the lending institutions
also make it difficult to see how you're going, claims Ms Mahalingham.
"It's like a credit card statement," she said.
"It gives you a minimum amount to pay, but you don't actually know
how long it will take to pay off if you just stick to the minimum
amount."
Experts agree that the key to getting all forms of debt under control
is to remember a few basic steps.
Firstly, debt that is not tax deductible should be attacked first.
If you have borrowings related to a business or to an investment which
generates an income, there's a good chance the interest cost will
be a tax deduction. Debt unlikely to be tax deductible will include
your own home loan, personal loans, credit cards and hire purchase
loans. You should try to reduce the loan with the higher interest
rate first.
Secondly, if you have a revolving line of credit, try to ensure that
you pay most of your bills as close to your next payday as possible.
The trick is to keep the loan balance down for as long as possible
during the month. For example, if you get paid on the 15th of each
month, try to hold off paying the bills through your line of credit
until just before the 15th of the following month.
If you are keen to see the line of credit paid off sooner, the accompanying
table should provide a rough guide. The monthly amounts equate to
a normal principal and interest loan structure. Let's start with a
$100 000 loan at 9% as an example. If you want to pay out your mortgage
in 15 years, the table shows the amount you need to leave in each
month is about $1014. If interest rates increase to 10.5% and you
want to stay on your 15-year plan, you'll need to increase the amount
to $1105 per month. You can adjust the amounts above quite easily.
If you have a $220 000 loan, multiply the value shown in the table
by 2.2 and if you have an $80 000 loan, multiply the value by 0.8.
Based on a $100 000 loan:
How much needs to be left in an account each month
| Interest
Rate |
7.5% |
8.0% |
8.5% |
9.0% |
9.5% |
10.0% |
10.5% |
| 5
years |
$2003.79 |
$2027.64 |
$2051.65 |
$2075.84
|
$2100.19 |
$2124.70 |
$2149.39 |
| 10
years |
$1187.02
|
$1213.28 |
$1239.86 |
$1266.76 |
$1293.98
|
$1321.51 |
$1349.35 |
| 12
years |
$1055.23
|
$1082.45 |
$1110.06 |
$1138.03 |
$1166.37 |
$1195.08 |
$1224.14 |
| 15
years |
$927.01
|
$955.65
|
$984.74 |
$1014.27 |
$1044.22
|
$1074.61
|
$1105.40 |
| 17
years |
$868.71
|
$898.26 |
$928.29 |
$958.80
|
$989.78
|
$1021.21 |
$1053.08 |
| 20
years |
$805.59
|
$836.44 |
$867.82 |
$899.73
|
$932.13
|
$965.02
|
$998.38 |
| 22
years |
$774.51
|
$806.18 |
$838.41 |
$871.17
|
$904.46
|
$938.25 |
$972.51 |
| 25
years |
$738.99
|
$771.82
|
$805.20
|
$839.20
|
$873.70 |
$908.70
|
$944.18 |
|
