You’ve probably heard a lot about short and long term debt, but do you understand the difference between the two?
There are long term debts which (as the name suggests) are over a long period of time and 99% of the time is an investment and therefore you are likely to gain from it – think mortgages where your home is the asset and is likely to grow in value, or student loans which provide a means to gaining a better education and therefore a higher paying (or more satisfying) job.
Then there are short term debts which, again, are just like the name suggests and should be for a short time period. They often have very high interest rates and for purchases that you aren’t necessarily going to gain from.
Below we have outlined the different types of short term debts and how they can each have an affect on your lifestyle. While some types of debt have a place, if you are learning to take control of your finances it would really pay to avoid them wherever possible.
Data from the Reserve Bank shows credit card debt is becoming increasingly unpopular with total credit card billing dropping 1.9% in February. However, it is certainly still there – with these stats relating to New Zealanders and credit cards:
- we owe approx. $6 billion in credit card debt
- 17% of us couldn’t manage their budget or finances without one
- 1 in 5 of generation Gen X relying on a credit card to get by.
As credit cards are unsecured debt, they have high interest rates attached to them (usually around 25%), and the minimum repayment amounts are set extremely low, often unreasonably low. This can lead to a credit card balance that you can’t seem to make a dent in and becomes longer term that you had originally planned.
An example of this is;
You have a $1,000 credit card balance, making only the minimum repayment amounts, you could be paying this debt off for 9 years, with a total interest cost of $1,024 – higher than the initial debt amount!
So be very careful! A simple way of looking at it is – if you don’t have the money for this, and it’s not an emergency, should you be using a credit card to pay for it?
Store Cards / Gem Visas / Q Cards
If you have ever gone to buy a new phone or furniture from the likes of Harvey Norman, it’s likely you were asked if you would like to pay for it using finance through a store card such as a Gem Visa or Q Card.
These store cards are much like credit cards however they can only be used at store ‘partners’ (each one has different store partners). There are usually some incentives such as interest free terms or no-repayment terms on offer as well to sweeten the deal. If you are disciplined with your finances, the interest free periods can make these cards an easy way to purchase something when you don’t have the funds to pay for it (or, in some cases, they can be used as a smart alternative to using funds you may already have, but we’ll save getting into that for another blog!).
However, because these cards also have very high interest rates, you could find yourself in a situation where you’ve come to the end of the interest free / no repayment period, you haven’t really paid much off and now all of a sudden you’ve got a debt that you’re struggling to pay off.
There are also some confusing processes that are followed when applying your payments to the outstanding balances that can mean what you think you are paying off isn’t always the case (this applies when you have multiple purchases on the one card / statement). More info around these processes can be found on the Money Hub website, a super helpful resource for all things money!
Personal Loans and Car Loans
Personal and car loans are usually managed through a bank, credit union, other money lenders or directly through a car dealer (and unfortunately finance options through car dealers are often not the best deal so ensure you do your research).
Interest rates across these lenders vary wildly but sometimes things like your credit score and credit history can have an impact on the interest rate and other factors you’re offered.
The most common reasons people get personal loans include debt consolidation, big one-time expenses such as weddings as well as urgent or unexpected costs like a car or medical bill. If you find yourself needing to apply for a personal loan, shop around for the best offer and borrow as little as you need so you can repay it as quickly as possible and limit the interest you will pay.
Both car and personal loans can be secured or unsecured – unsecured is a higher risk for the lender therefore you’ll usually have a higher interest rate. If it’s secured, and you fail to repay the loan, the lender can take the security to gain some of the loan back (such as the car).
In the case of personal and car loans, you really need to determine what the true cost of the purchase will be, by the time you pay the loan back adding on the interest you will pay.
An example of this (shown) is a car loan. In this example , by the end of the 3 year term, you would have paid 1.021 times the original purchase price (also remember the minute you drive a car away after purchase the car has lost value so it definitely wouldn’t be worth $14,554 after 3 years!)
Laybuys, Afterpays etc.
Yes, these are classed as debt (especially in the banks eyes), and although they are more short term than credit cards (4-6 weeks), if you don’t keep in control of these and end up with multiple at one time, they can become very hard to manage and you may find yourself in financial trouble.
When you have multiple AfterPays/LayBuys you’ll often end up with different payment dates and amounts. This is an easy way to lose track of what the total amount actually is, and end up with more than you can afford.
The bonus to these payments types is they are very short term and there is no interest being charged, so you never pay more than the original purchase price. Your success with Afterpays or Laybuys depends on you and how you manage them. If you can limit your spending and manage one at a time it’s a great alternative to a credit card.
So, as you can see, there are a number of different short term debt types, all with differing purposes and ways of working. As mentioned a lot throughout this blog, if you are good with your finances and money management you may be able to avoid falling into the trap of having too much short term debt and struggling to pay it back.
However, some good rules to follow before ticking that next item up is:
- Always think twice and ensure you can afford the repayments.
- Ask yourself – do you really need to borrow the money / have short term debt for this?
- Could you wait and save some money instead?
- Give yourself a 24 hour stand down period – you’ll often find the consumer itch will disappear.