There is no nice way to put this. Banks hate debt, unless it’s them who is loaning you the money. It is such a big factor in buying your first home that we’ve dedicated a whole section of the website to helping you control it.
When it comes to getting a mortgage, debt is one of the three most critical factors alongside the size of your deposit and your ability to actually pay back the loan. The less debt you have (personal loans, car loans, credit cards, student loans etc), the more the banks will consider lending you.
Conversely, if too much of your income is being used to make debt payments, you will find it very hard to get a mortgage regardless of how big your deposit is. Any potential lender will need to see that you have your debt levels well within their very strict guidelines.
So! Given the importance of having minimal or no debt, as a potential first home buyer you’ll want to get rid of as much existing debt as you can. It can be done, and involves three main parts…
• Getting serious.
• Identifying exactly how much you owe, and to whom.
• Putting a strategy in place to get rid of it.
Each of these are covered in detail in the dropdown windows below…..
Getting Serious
This is a simple concept, but super important if you are to achieve your goal.
Getting serious means not only tackling your existing debt, but also not going into further debt. Serious potentially means chopping up your credit cards, thereby avoiding the temptation of putting that “bargain” on tick. Or putting up with your existing car, rather than buying a newer one on some “low deposit, no repayments for 12 months” type arrangement. These deals may may sound attractive, but this is all consumer debt that the banks will hold against you come mortgage application time.
Serious definitely means putting a budget together, so you know what your income is, what your expenses are and how much you can actually afford to put towards debt payments. If you have a budget, great. If not, there is a plethora of information available on how to set one up that works for you. Here are just a few websites and videos to get you started…..
4 things every budget should have https://www.youtube.com/watch?v=_zggCPuiomw
Sorted – How to start a budget https://sorted.org.nz/guides/planning-and-budgeting/how-to-start-a-budget/
Dave Ramsey – How do I make a budget and stick to it? https://www.youtube.com/watch?v=4Eh8QLcB1UQ
Another valuable resource available to Kiwis are the various debt advice / budget planning services available through Citizens Advice Bureau. cab.org.nz
If you would like to talk with somebody about your debt situation this is a great place to head.
You will also need to discuss any debt reduction strategy with your loved ones, to make them aware that you are writing a new chapter in the family financial history. Getting buy in from them is critical – if you can work together to eliminate your debts it will be a life changer.
Listing your debts
Next step is to identify all your debts, and either write them down or (ideally) list them in a spreadsheet. Beside each debt you will want to have the following information listed also…
• The balance of the debt
• The interest rate being charged
• The minimum payment for each debt and payment frequency (weekly, monthly etc)
• The term of the debt (not applicable if it is a credit card – banks are happy for you to carry a negative balance for the rest of your life)
The beauty of loading this info into a spreadsheet is that you can sort your debts by either balance or interest rate. This will come in handy when deciding which debt reduction strategy suits you best.
Got everything listed? Great. Let’s look at two of the best and most proven Debt Repayment strategies to get these debts off your back…..
1. Debt Snowball
Debt Snowball and its cousin Debt Avalanche are two well known and respected ways of eliminating debt over time. The Debt Snowball strategy, which is arguably the simplest method, involves listing all of your debts from smallest to largest, and attacking the smallest debt first.
You will need to keep up any minimum payments on the other debts, but the Debt Snowball works by concentrating your energy on getting the smallest debt paid as soon as you can. Once this debt is paid off, any income that was used to pay off this debt can now be concentrated on the next smallest debt. Keep working in this fashion until only your largest debt remains. All income that was used to pay off the other debts can now be concentrated on this last one until it is gone and you are completely debt free.
Advantages of Debt Snowball…
1 It is simple to understand. Simply follow the smallest to largest formula.
2 Quick wins. By attacking the smallest debt first you should be able to get rid of it in a reasonably short period. The satisfaction of getting even this small debt off your back will give you the incentive to keep going.
But shouldn’t I tackle my largest and most painful debt first?
Looking at it just by the numbers, it would usually make more sense to attack the debts starting with the one charging the highest interest.
In real life however, human nature dictates that we like to see fast results in order to keep going. It’s just as true with paying debts as it is with dieting! The Debt Snowball method is effective because it takes the need for (almost) instant gratification into account.
If you would like to watch a video on the Debt Snowball method, one we recommend is from Marko Zlatic of Whiteboard Finance in America. You can check out Marko’s video here…….
https://www.youtube.com/watch?v=pftx9Jx6N1Q
There are loads of other videos on the subject, so just do a “Debt Snowball” search on your favourite video channel, grab a coffee and immerse yourself. Good luck!
2. Debt Avalanche
The Debt Avalanche method is similar in concept to Debt Snowball, however the debt payments are prioritised not by size but by interest rate.
If for instance you have a car loan at 12% interest, credit card debt charging 20% interest and a student loan charging 5%, regardless of the balances you would prioritise them as follows…
Credit Card/s 20%
Car loan 12%
Student loan 5%
The avalanche strategy would involve making minimum payments on the car and student loans, while pouring as much energy and income as you can into paying off the credit card/s. Once the credit card debt has been repaid in full, you would then focus on paying off the car loan as soon as you can. Once the car is fully paid off you would then tackle the student loan until that too has gone.
The end result? Hard earned income that was previously used to pay off debt can now be used to build that first home deposit. You have taken control.
Advantages of Debt Avalanche…
1 It makes mathematical sense. Paying off the highest interest bearing debt first means your money is working the hardest for you. In theory, paying off a debt charging 15% is the same as getting around a 20% return (pre-tax) if the money was invested.
2 It’s the quickest way to pay off your debts overall. Because you are paying off the highest charging debt first, your overall interest payments reduce faster over time than with the Debt Snowball method.
Disadvantage of Debt Avalanche.
It takes discipline. Because the highest interest bearing debt may also be one of your biggest debts, the “quick wins” you would typically get with the Debt Snowball method aren’t there to be celebrated. So you do need to be patient and stick to the strategy for it to work. Over time though, the Debt Avalanche would clear debts faster than someone with the same debts using Debt Snowball.
Most online videos do comparisons between the Debt Avalanche and Debt Snowball methods, which is fine as you get a good understanding of both.
As well as Marko’s video mentioned in the Debt Snowball section, we also recommend a video by Next Level Life which provides an example as to how both strategies can be applied to the same list of debts…. https://www.youtube.com/watch?v=jtgnRJKSJlw&t=37s
Again, we wish you the best of luck on your debt reduction journey. If you do have any questions on how this all works, please feel free to get in touch using our Contact Us page.
What about Debt Consolidation loans?
Debt Consolidation loans are offered by most, if not all major money lenders in New Zealand. They do what they say on the tin, allowing you to lump all of your debts into one meaning you only have one regular payment to make.
These types of loans can work (and the interest rate may be lower than what you are paying), but you need to be very careful. The major downside is that you now have just one debt, but potentially a bunch of credit cards with zero balances and access to other credit as well. It is way too easy to start tapping back into all this credit again, leaving you worse off than when you started because now you have the Debt Consolidation loan to pay back also.
If you do get one of these loans, to actually make it work it would pay to cancel your credit cards and other lines of credit completely (which as a bonus looks much better on a mortgage application). Otherwise it’s not a debt reduction technique, it’s more of a “rearrange the deckchairs on the Titanic” strategy with the potential to hit a second iceberg.