Debt, according to Oxford dictionary, is “a sum of money that somebody owes”. To many of us, it means having the added stress of having to repay our debt at the end of the month. For example, if we borrow money to buy a house or car, we know that we have to make monthly repayments for the loans that we took.
These types of debts are obvious – and we should carefully consider our ability to afford each type of loans before we take them. However, there are also debts that are less obvious, and which some of us may unwittingly take on without even realising it.
#1 Paying By Instalments
Paying by instalment is a payment method that has its place. It helps you manage cash flow and allows you to buy big-ticket items on a budget. While paying by instalments may offer a great way to own that new iPhone 12 or a luxury bag, they can add up. Throw in some furniture and electronics and you’ll end up with a much bigger bill at the end of the month when instalments are accumulated.
This is debt that can quickly and quietly snowball into a much larger amount if you don’t keep track of your payments.
Stores typically partner with credit card or payments companies to offer such interest-free payment plans. They can range from as short as three months, to as long as 36 months. Think about it, if you choose the latter plan, that means it will require you three years of commitment to paying off the item. During this time, if you miss a payment or choose early repayment, you’ll be hit with a slew of penalties and interest charges. Since it is the bank that paid for your purchases first, you are technically still in debt until you have repaid the full amount.
#2 Not Paying Credit Card Fees In Full
Credit cards are great because they are convenient and more secure than using large sums of cash. They offer more purchasing options (such as online shopping) and you can earn points or miles to redeem for discounts or other rewards.
Credit card companies offer a choice to either pay the bill in full or just the minimum sum. If you pay in full, there will be no extra fees or interest added. However, if you choose to only pay the minimum sum, the monthly interest kicks in. For most banks, it’s a whopping 25.9% per annum. There’s also a late payment fee if you don’t pay on time. Based on these figures, a $5,000 bill can snowball to more than $7,682 in a year.
And when you choose to pay only the minimum sum at the end of the month, you are essentially choosing to go into debt.
#3 Recurring Subscriptions That Comes With A Lock-In Period
Recurring memberships and subscriptions that come with a lock-in period can be seen as a type of debt. While you might be paying a monthly subscription, you can’t just discontinue your subscription as and when you want. This means that the plans, which are typically billed every month, are a cost commitment, whether you use them or not.
For example, if you sign up for a 2-year gym membership at $100 a month that you cannot cancel, you are on the hook for the bill and are required to pay the gym the amount every month, regardless of whether you use your membership benefits or not.
#4 Investing on margin/leverage
Investing on margin means borrowing funds from a bank or broker to invest in stocks/forex/etc for higher returns. Using this type of leverage is a “win big, lose big” scenario, a risky strategy that could potentially magnify your gains and losses. On the upside, you would be able to invest more even when you don’t have available cash.
On the downside, your losses are magnified if prices decline. Since you are using borrowed money, you also need to pay the interest on the margin loan. Any borrowed amount equals to debt incurred, and margin trading can accentuate it. Worse, if the value of your investments drops beyond the minimum value, you may face a margin call. You’ll have to top up your margin account by depositing funds or sell shares in your account.
#5 Not refinancing your housing loan
While a housing loan is often considered “good” debt – it enables you to own property and build equity – you could potentially be paying more than you should. This sneaky form of debt is due to the difference in interest rates. The COVID-19 pandemic has resulted in lower interest rates. If you refinance with another bank that offers a more competitive rate than your current loan, you can achieve savings over the long term and reduce your debt. By not refinancing, you are also incurring higher debt than you need to.
For example, the total interest payable for a $500,000 loan at 1.5% interest over 25 years is $187,500. Switching to another loan with a lower rate at 1.3% would incur $162,500, a savings of $25,000. Do check, however, if you are still within the lock-in period as there would be a penalty fee. There are also additional conveyancing and valuation fees. Still, it’s worthwhile to do the sums and you could come away with significant savings in the long run.