Debt is a part of everyday life for most Singaporeans. Whether it was paying for a holiday with credit cards, to taking on a renovation loan or a home mortgage, you’re likely to have experienced dealing with debt at some point in your life.
By itself, debt isn’t a bad thing. In fact, it is debt that makes possible many of the transactions we need to carry on with our modern lives.
Debt that helps you to build wealth, such as if you borrow to invest in profitable property, is considered good debt. However, most of us face the more common form of debt, which is money we owe to another party — be it a person or an institution — which must be repaid.
You may have heard that consumer debt in Singapore is serious enough that the government has stepped in with curbs and measures to try and turn back the tide. These include suspension of credit facilities and borrowing restrictions.
Lest you fall prey to the debt trap, here are two crucial things you need to know about debt, and how to get rid of it once and for all.
Our biases make debt appear less urgent
Which seems worse? Withdrawing $20,000 from your savings account to pay for your wedding banquet, or paying interest charges on four credit cards maxed out at $5,000 each? It seems irrational, but the average person seems to find the credit card situation a little more bearable. People tend to think that spending on credit cards is somehow less immediate and painful than having to fork out cash. Also, mental accounting (which is a cognitive bias that affects how we think) can cause us to treat money in different accounts differently, even though our assets and liabilities affect our individual net worth equally.
And that’s how credit card debt happens. Before we know it, we’re tens of thousands of dollars in debt, and are barely able to keep up with the interest payments each month.
Here’s how you can remove the sway of your cognitive biases. Consolidate all your finances into one simplified statement with only two numbers on it – what you have and what you owe. Do this across all your savings accounts, and your credit cards. (And personal loans too, if you have any.)
Adding up all your debts and comparing that figure against your cash assets will erase the effect of mental accounting and help you clearly see your financial status. This should provide the motivation and urgency you need to get moving to clear your debt.
But the final tally may give you a mild heart attack, and the situation may seem bleak, even hopeless. This is when you break down your debt once again, so you can tackle it effectively. Set targets to pay off one card at a time, starting with the smallest amount, and work your way up.
Lowering interest is the key to defeating debt
Paying off your debts through steady monthly payments is a simple and solid strategy that works, but only under certain situations. It all depends on the type of debt you have.
If your debt is in the form of a personal loan, and you are able to keep up with the monthly payments, then carry on until your loan is paid off. Nothing fancy needed here, just sheer patience and #grind.
However, if your debt is in the form of credit card balances that roll over each month, then blindly paying the minimum amount each month won’t solve your problem. (Just as an illustration, owing around S$10,000 on a typical card will incur interest payments of around $300 each month. And you’d have barely made a scratch in the $10,000 you actually owe!)
What makes credit card debt so dangerous is the compounding interest that is charged on your roll-over amount. Hence, the more you pay each month, the less interest you incur, and the more progress you make in clearing your debt.
But what if you don’t have the cash to pay more than the minimum each month? Then you should lower your interest charges, either via a balance transfer or a personal loan. Both of these financial products work differently, but they can both temporarily stop your debt from ballooning, giving you a chance to catch up.
It’s best to speak with your bank for detailed advice on how to lower your debts this way. Don’t forget to take advantage of any promotions that can further help you save money.