Advice for eliminating bad debt

[Witzl]

Well my partner and I have been going back and forth over the best way for us to eliminate our bad debt, and we cant agree. So i would like to get some outsiders opinions on what might be the best way to pay down our bad debt.

Here's our situation:
- we have one IP, which is being refinanced now to draw down $60K equity (refinance about to complete now)
- shortfall is $700/mth
- I have $24K in a personal loan, which is baggage from my idiotic youth
- We also have a $3k and a $2k credit card which we use for expenses and purchases (both regular and one-offs)
- We rent a place for $390/wk, with a border at $120/wk
- we both earn the same money, around $60K


Up until now, my partners income has been covering the shortfall on the IP, and paying our rent (her loan was fixed at 6.2%). Any leftover has been absorbed by things like strata, rates, living expenses etc

My income has been covering the remainder our living expenses, clearing our credit cards each month, and then we usually put about $2000-2500 onto my personal loan. This hasnt been working so well lately since my the interest rate just went up on the mortgage of our IP, so we are looking for ways to get the personal debt down faster, as it is a hinderance to our borrowing power.

My idea is that since we have about $60K from the refinance, we can put aside about $5-10K of that to cover the shortfall on our IP (about $700/mth) whilst we concentrate on eliminating that personal debt.
Of course that will erode the equity a little, but my thoughts are that it would be speeding up the elimination of the non-deductable debt, giving us an extra $700/mth to pay it down.
Once the debt is eliminated, the plan is to then cover the shortfall from our incomes, and save the remainder of what we would have otherwise been using to eliminate the personal debt (until such time as we buy more IPs).

We could pay out the loan with our equity, but we would rather not. We would like to improve our cashflow management and maintain as much equity as possible.




So what are everyones thoughts and suggestions?
Ive read a few threads about eliminating personal debt, but most of them seem to focus on turning around the consumer spending habits, which we have already addressed. This is more a question of the best way to eliminate pre-existing personal debt to help move forward on our property accumulation.

Thanks in advance

 

[Property Meister]

there are lots of ways to do it, its personal, numbers etc

but generally, people recommend you get rid of the highest interest rate first,

so the credit cards, cut them up if you can't control your spending,

don't buy luxuries, eg coffee at the coffee shop, bring lunch to work, sell unwanted stuff lying around the house etc. etc.

it all depends on how badly you want to reduce the debt and how quickly!!

do you live a lavish lifestyle?? if so thats a good starting point to cutting out stuff... its not easy but it will lift a big weight off your shoulders!

ooops.. i just read your whole post..... unfortuantely, its your spending habits or mindset that have got you into the current situation, so if you won lotto and paid it all off today, you wil be in the same situatuon down the track because your mind set hasn;t changed.
it would be better to get rid of the existing debt as quick as possible eg credit cards at 15%-20% or whatever as your assests, eg property generally won;t increase at this rate in the long term.....

 

[GoAnna!]

I think that as long as you have the disipline to carry through with the plan focusing on paying off the personal loan makes most sense. And I agree that using the equity to cover the holding costs as you focus on the personal loan makes sense as long as you don't revert to higher living expenses. It will result in improved cash flow and lower non tax deductible debt.

Do you have a PPOR? If not you might want to place any excess payments in 100% offset account rather than directly into the loan itself. This will give you maximum fleability down the track.

 

[feihong]

Well my partner and I have been going back and forth over the best way for us to eliminate our bad debt, and we cant agree. So i would like to get some outsiders opinions on what might be the best way to pay down our bad debt.

Here's our situation:
- we have one IP, which is being refinanced now to draw down $60K equity (refinance about to complete now)
- shortfall is $700/mth
- I have $24K in a personal loan, which is baggage from my idiotic youth
- We also have a $3k and a $2k credit card which we use for expenses and purchases (both regular and one-offs)
- We rent a place for $390/wk, with a border at $120/wk
- we both earn the same money, around $60K


Up until now, my partners income has been covering the shortfall on the IP, and paying our rent (her loan was fixed at 6.2%). Any leftover has been absorbed by things like strata, rates, living expenses etc

My income has been covering the remainder our living expenses, clearing our credit cards each month, and then we usually put about $2000-2500 onto my personal loan. This hasnt been working so well lately since my the interest rate just went up on the mortgage of our IP, so we are looking for ways to get the personal debt down faster, as it is a hinderance to our borrowing power.

My idea is that since we have about $60K from the refinance, we can put aside about $5-10K of that to cover the shortfall on our IP (about $700/mth) whilst we concentrate on eliminating that personal debt.
Of course that will erode the equity a little, but my thoughts are that it would be speeding up the elimination of the non-deductable debt, giving us an extra $700/mth to pay it down.
Once the debt is eliminated, the plan is to then cover the shortfall from our incomes, and save the remainder of what we would have otherwise been using to eliminate the personal debt (until such time as we buy more IPs).

We could pay out the loan with our equity, but we would rather not. We would like to improve our cashflow management and maintain as much equity as possible.




So what are everyones thoughts and suggestions?
Ive read a few threads about eliminating personal debt, but most of them seem to focus on turning around the consumer spending habits, which we have already addressed. This is more a question of the best way to eliminate pre-existing personal debt to help move forward on our property accumulation.

Thanks in advance

This is something I have thought about and I've come up with something which is yet to be tried and tested but may work:

Apply for a super low interest rate credit card. Capitalise all the shortfalls onto this credit card so that the interest rate on this credit card is fully deductable. Meanwhile, pay off your bad debt with your salary and rent.

It's virtually a loan swap from bad debt to good debt. From what I read from the thread on this forum it should be perfectly legal.

 

[Witzl]

I probably shouldve said, we are already well in control of our spending. We take our lunches to work, dont drink coffee... etc etc - we are really good with our spending. Heck, we even drive sub-$2000 corollas which i usually repair myself and cost buggerall to run.
Our living expenses are quite minimal really, much much better than most people our age.

We dont have a PPoR, we dont see the need at the moment. We plan to make our wealth and buy the PPoR from a part of that with a much reduced mortgage. We are only 26, so the PPoR isnt a necessity yet.


Feihong - your idea sounds good in theory, but not really interested in going too silly with various extra forms of credit. I might look into it from a numbers perspective though, just for personal interest.

 

[HiEquity]

If you pay out a personal loan with equity then the new loan won't be tax deductible either as it will be used for personal purposes so you will still have bad debt, just at a lower rate! Bad idea...

As I think you allude to, you can allow interest to capitalise on your IP loan and use the freed up rent and personal income to pay down the personal loan asap. This would preserve the tax deductibility of the new IP loan as it would just be servicing investment debt. Good idea!

Are you both using income tax witholding variations (ITWV)? This frees up cashflow to pay down bad debt faster... Good idea!

And of course most of the gains will be made with whatever discipline in savings you can muster... On those numbers the job shouldn't take too long if you set your mind to it! Best idea!

Don't forget to check everything with your accountant... I know nothing!

 

[feihong]

As I think you allude to, you can allow interest to capitalise on your IP loan and use the freed up rent and personal income to pay down the personal loan asap. This would preserve the tax deductibility of the new IP loan as it would just be servicing investment debt. Good idea!

That's what I had in mind when I was talking about getting a credit card. Essentially, IP equity loan and credit card are virtuall the same (albeit one with higher interest), and the concept of capitalising interest into IP equity loan can be equally applied to credit card.

 

[steveadl]

My idea is that since we have about $60K from the refinance, we can put aside about $5-10K of that to cover the shortfall on our IP (about $700/mth) whilst we concentrate on eliminating that personal debt.
Of course that will erode the equity a little, but my thoughts are that it would be speeding up the elimination of the non-deductable debt, giving us an extra $700/mth to pay it down.

As long as you don't use any of that $60k to pay down the personal debt, otherwise you're just making a portion of that $60k non-deductible as well and end up in the same place.

The $60k musn't get used for anything other than investment purposes. If you capitalise your IP interest for a few months and use the resulting excess income from your jobs to pay down the personal debt quicker, then this is fine. Perhaps this is what you meant?

If you use that specific $60k to pay down as opposed to your income, then you're spinning your wheels.

 

[HiEquity]

That's what I had in mind when I was talking about getting a credit card. Essentially, IP equity loan and credit card are virtuall the same (albeit one with higher interest), and the concept of capitalising interest into IP equity loan can be equally applied to credit card.

I agree - the numbers will look better with a zero interest short term credit card strategy. If it was me though I would just focus on keeping it simple and paying down quickly...

 

[The Y-man]

Time to look for second jobs?

Cheers,

The Y-man

 

[Witzl]

Yeah i meant to say that the $60K would be used to capitalise the interest on the IP whilst we pay down the personal debt with our freed up job income, and maybe the rent from the IP as well.

I actually hadn't thought to use the rent from the IP to pay down the debt... that would take a large chunk out of our $60K equity which we were hoping to retain for deposits on the next two IPs we plan buy towards the end of the year/early next year.

 

[feihong]

Yeah i meant to say that the $60K would be used to capitalise the interest on the IP whilst we pay down the personal debt with our freed up job income, and maybe the rent from the IP as well.

I actually hadn't thought to use the rent from the IP to pay down the debt... that would take a large chunk out of our $60K equity which we were hoping to retain for deposits on the next two IPs we plan buy towards the end of the year/early next year.

well, once you pay down your personal debt, you can then use that loan for your next IP purchase rather than your existing equity, and even better, it's deductible this time

 

[LynnH]

Witzl

Have you read Simon's excellent post ...

http://www.somersoft.com/forums/showthread.php?t=24892

Simon's approach is basically to pay the minimum payment per month on all borrowings, convert P&I loans to IO, and put any extra money into paying down the smallest debt (so that it is eliminated a.s.a.p.) then put the extra money + the minimum payment you were making on the smallest debt into the next smallest debt, and so on until all debts are eliminated.

John Burley also follows a similar approach in his book, Money Secrets of the Rich.

Cheers
LynnH

 

[Witzl]

Time to look for second jobs?

No thanks. Been there, that sucks.
We already have a border in our house, which helps a lot with cashflow (to the tune of $140/wk)... working a 2nd job just puts excess strain on the relationship and takes away from that resource you simply cant replenish - TIME.

 

[Witzl]

well, once you pay down your personal debt, you can then use that loan for your next IP purchase rather than your existing equity, and even better, it's deductible this time

I find your ideas intriguing; i'd like to subscribe to your newsletter.

... i hadnt thought about that actually! The personal loan does have a redraw facility, so i can most certainly pay it down then use it as a deposit for a house.


LynnH - yep, read Simon's post already. It covered things more to do with changing spending and finance habits, which we have already done. Now we are trying to focus on the most effective way to pay down the personal loan debt quickly.

 

[The Y-man]

Our living expenses are quite minimal really, much much better than most people our age.

.... about $2630 per month (not including rent) according to your figures in the first post? Agree, not extravagant even from a Melbourne perspective, let alone Syndey.

Cheers,

The Y-man

 

[Witzl]

yeah thats probably about right, can vary up and down a little.
Our rent is only $390/wk... minus the $140/wk our border pays

Like I said, we think we have our expenses under control pretty well - save for the odd doodad purchase, which we think we deserve for having been so good with our money for the past year. You have to have *some* reward for your hard slog

 

[ruroshin]

I actually hadn't thought to use the rent from the IP to pay down the debt... that would take a large chunk out of our $60K equity which we were hoping to retain for deposits on the next two IPs we plan buy towards the end of the year/early next year.

You probably want to consult with your accountant but I thought that rent from an IP must go towards paying for that IP's loan otherwise you cannot claim tax deduction on the interest from that loan.

 

[Witzl]

Yeah i would have to check... of course

 

[The Y-man]

You probably want to consult with your accountant but I thought that rent from an IP must go towards paying for that IP's loan otherwise you cannot claim tax deduction on the interest from that loan.

Rental income is treated the same as any other income (eg salary/wages). You can use it any way you please (well, that's my take on it....)

Cheers,

The Y-man