Financial planning is really about… consolidating credit card debts

Credit Card debt is always best avoided. Credit cards that incur interest are incredibly expensive. Any situation where a client is paying interest on a credit card must be addressed in a thorough SOA.

The average interest rate payable on credit cards is over 17% per annum and average interest bill for those who pay it is $700 per year. As this interest is typically not tax-deductible, this equates to an effective pre-tax interest rate of almost 27% for a person earning more than $80,000 per year. What this means, of course, is that paying down interest-bearing credit card debt will earn such clients a guaranteed 27% pre-tax return per year.

Not even Warren Buffett in one if his best years can beat that type of return.

Managing credit card debt typically takes a little more strategy than managing a home loan. This is because a person with credit card debt is unlikely to have any spare cash available to pay down the debt. But this does not mean that nothing can be done. Typical moves to reduce or eliminate credit card debt via consolidation can include:

  • Consolidating credit card debts by redrawing on a home loan;
  • Consolidating credit card debts by establishing a personal loan to pay out the credit card/s; or
  • Consolidating credit card debts into a new credit card facility offering interest free periods on credit card transfers – and then working feverishly to eliminate the debt during the interest-free period (after which the credit card issuer starts to charge an even higher interest rate). 

If consolidation cannot occur, there are still some ways to help. Consider the following:

  • Where there is more than one credit card: targeting the card with the highest interest rate applicable to be repaid first;
  • Negotiating with the credit card provider; or
  • Selling something and using the proceeds to pay down debt.

The general point is this: don’t let credit card debt remain unattended. 

Credit Licencing: Where an adviser simply points out the benefits of debt consolidation and leaves the client to organise the loan which will be used for the consolidation, the adviser will not breach the credit licencing rules. You can read more about these rules here

Adviser tip – here is how you might suggest it

Can you see these paragraphs in your next SOA:

“I suggest you ask your bank manager to increase your home loan by an amount equal to your credit card debts, and that you use this to pay off your credit cards. Consolidating your debts into the lower cost home loan will save you about $2,000 cash a year and this is the same as earning an extra $3,000 of salary.

I recommend that you do not spend the extra cash and that you instead increase your home loan payments by $2,000 a year. Doing this will save you a total of $40,000 interest over the next twenty five years, and reduce term of your home loan by about 4 years. This is shown here:

Effect-of-consolidating-a-credit-card-debt-to-a-home-loan

(Assumption: 5% interest rate, 25 year loan term)

The Dover Group