In the long run, it pays to wipe out debt

THE Barefoot Investor answers Herald Sun readers’ questions on saving, borrowing, investing and all things finance.

In the long run, it pays to wipe out debt

Q My husband and I have a combined income of $115,000, but we don’t have any savings because we’re too busy paying down $19,000 of credit card debt, which is at 0 per cent interest for the next 14 months.

However, we want to buy a $500,000 home soon, using my parents as guarantors.

Should we wait until all the debt is paid off to apply for a loan, or just incorporate the remaining debt into the home loan once the interest-free period runs out?

Ellen

A Hi Ellen,

Having that much credit card debt is the financial equivalent of being an obese chain smoker.

And you’re wanting to sign up to run a marathon — provided your poor old parents run alongside you with a wheelchair in case you don’t have the ticker to finish.

OK, so I’ll stop with the analogies, but hopefully you’ve got the point. I think this is a very, very bad idea, for you and especially your parents.

The best thing your parents could do for you is nothing at all. If they leave you to it, in 30 years you and your husband will look back on the “lean” years with pride — eating noodles while you pay off your credit card, saving for a deposit, buying a cheap little unit, sprucing it up with a lick of paint, and eventually trading up to a family home.

That’s the sort of stuff that builds character and puts you on a firm financial footing for whatever life throws at you, especially at the start of your marriage.

Having everything handed on a silver platter by your parents does the opposite.

RETIREMENT IS NOT AN OPTION YET

Q I’m worried for my parents. They are 58 and 55 and looking like they’ll have to sell the home they built four years ago to have enough money to retire. They currently have a combined income of $116,500 per year with about $330,000 super in fixed interest.

The house they built is valued about $600,000, with $280,000 left on the mortgage.

Is there any way they can save their house and have enough money to retire in about five years’ time?

Ross

A Hi Ross,

Essendon has a better chance of winning the flag this year than your parents do of retiring in the next five years.

The numbers don’t stack up. They’re going to need to keep working for at least another 10 years.

Over that time they should focus on salary sacrificing as much as they can into their super, as well as making after-tax contributions in the lower-earning spouse’s name to take advantage of the government co-contributions scheme.

This is essentially free money from the Federal Government if you earn under $49,488. While they’re tuning up their super, I’d strongly suggest they move their money out of fixed interest and into growth assets like shares.

If they do all this they won’t need to sell their home: though it’s never a bad idea to look at downsizing.

I strongly believe retirees should own their own home outright when they retire.

STOP LIVING ON BORROWED TIME

Q My wife and I own three investment properties worth a total value of about $1.9 million, but with a debt level on those at about 83 per cent.

Thankfully, the rent covers the costs of the properties, and we’re able to live and save off my $80,000 salary.

Yet we only have a limited savings of $10,000. My concern is that it could all go very wrong very quickly with this amount of debt.

With two kids to look after, I’d rather have a plan to make this all a little safer. What would you suggest?

Jason

A Hi Jason,

By the way you’ve written your question, it sounds like you’ve already worked out that you’re living on borrowed time. I don’t see how you’re keeping your head above water with $1.57 million in debt, the out-of-pocket costs for maintenance and repairs of the properties, and raising two kids, all on $80,000.

It’s got to be tight. When interest rates go up — and eventually they will — you’ll be toast. However, right now ultra-low interest rates are giving property prices a push, so it’s a great time to sell at least one (preferably two) of your properties, radically reduce your debt levels, and start saving.

ENSURE YOUR BOND REMAINS STRONG

Q Ever since my 11-year-old daughter was born, I’ve put $100 a month in a bank account for her, and earned as high interest as I can get. Today that account has $18,000 sitting in a Bank of Melbourne account earning 4 per cent interest.

The account has always been in her name, as even I don’t want it to interfere with my tax. Now I want to look for an alternative that would allow the money to stay in her name for the next 10 years — perhaps shares or another savings account?

Michelle

A Hi Michelle,

Congratulations on socking away the regular savings. You’re teaching your daughter great discipline. Now let’s teach her about compound interest and the power of becoming a part owner in profitable businesses: if you had invested that money in shares instead of a bank account, you would have an extra $2500 today.

I’d suggest you open up an investment bond, which you can open up in your daughter’s name without a tax file number. You can choose your investment option within the bond (choose Aussie shares with low fees), and you can continue your monthly savings plan, even easier, you can automate it.

After 10 years the bond is capital gains tax free, which means if you continue on that path you should be able to give her a cheque for $60,000 on her 21st birthday.

Originally published as In the long run, it pays to wipe out debt