Tips to avoid ‘toxic’ debt: How to escape for good

With interest rates rising, and cost of living pressures mounting, many Aussies are struggling to manage debt right now. If you’re one of them, it’s important to know that there are strategies and support out there to help you alleviate some pressure and start to financially recover from toxic debt.

What is toxic debt?

Toxic debt refers to loans or other forms of credit that have a low chance of being repaid. This may be because the borrower is struggling financially to make the repayments because they have borrowed more than they can afford, or their circumstances have changed and made making repayments difficult. The debt can be toxic for both the borrower and the lender.

Signs you could be heading for toxic debt

Could you be heading towards toxic debt, or even dealing with it right now? Here are some signs to look out for:

• Living on credit. If your take home pay is not enough to sustain your cost of living, you might fall into the trap of relying on credit cards, or buy now-pay later services to purchase everyday items. This is an instant warning that you need to adjust your spending habits, or risk falling into toxic debt down the track. Credit cards and buy now-pay later often come with high fees and interest rates, making it difficult to manage and stay on top of your repayments.

• Low credit score. A credit score is a number that helps to represent your trustworthiness as a borrower. When you apply for any type of credit like a home loan, personal loan or credit card, your lender will usually check your credit score. If you have a poor history of borrowing money, your credit score will be lower and might mean you have to pay a higher interest rate. This can be a vicious cycle, because those already struggling with debt are going to get hit with higher interest rates, making it more difficult to stay on top of their repayments. If you’re trying to access credit, and your credit score is low, this is a sign you may be heading for toxic debt.
• No genuine savings. If you’re living pay cheque to pay cheque, and can’t save money, it may be a sign you’re heading towards toxic debt. Throughout life, emergencies and unexpected costs can come at any time. It might be a medical bill, car repairs, or losing a job, but without savings these costs can force you into debt. Having a savings account that’s increasing (even if it's slow) can provide a safety net should one of these costs come up out of the blue.

Tips to help avoid toxic debt

If you’re keen to take control of your finances and ensure you don’t fall into toxic debt, there are some things you can do.

Make a budget

Managing money is a skill, and it takes time to develop. A simple and easy way to stay on top of your finances and avoid debt is to make a budget. A budget is a list of your income and expenses. It can be helpful to categorise the spending into essential and non-essential costs. Examples of essential spending are:

• Rent
• Groceries
• Bills (water/electricity)
• Car/personal loan repayments
• Petrol
• Phone plan
• Insurance.

Non-essential spending is the other things we might be spending money on. By simply listing them, and how much you are spending each week or month, it can be easy to identify where you can make changes.

Examples of non-essential spending:

• Streaming subscriptions
• Alcohol
• Takeaway
• Gym memberships
• Online shopping
• Entertainment
• Restaurants or clubbing.

If you’re applying for a loan, consider a secured loan over an unsecured loan

Generally, loans come in two categories, secured and unsecured. A secured personal loan means the loan is secured by an asset. If you fail to meet your repayments, the lender can sell the asset to reclaim the money you owe. A common form of a secured loan is a car loan, where the money you borrow is used to buy a vehicle. If you fail to make repayments, the lender can sell the car to pay off your debt. This may seem like a scary proposition, but it may help you secure a lower interest rate, helping reduce the cost of the loan.

Create an emergency fund

Staying ahead on your finances during tough times often comes back to how well you’ve prepared beforehand. Cash in your emergency fund can ideally sit in a high-interest savings account you can access if you need quick cash to pay for essential items as cost of living increases.

A common goal is to save enough to cover six months of expenses should you be without work, or take a significant pay cut. This may seem like a lot at first, but if you save a little each week, your savings will build up.

Prioritise credit card debt

Credit card debt often comes with high interest rates. If you‘re paying the bare minimum on a credit card debt, you are essentially kicking the can down the road, because the interest costs make it hard to get ahead. You may have to cut back on spending in other areas, but it could help you pay less interest over the life of the repayments.

Check your borrowing power

When you plan to take on debt, you should carefully calculate your borrowing power. This is an estimate of what you can afford to borrow. Lenders will also assess this but, to protect yourself, you should look at your budget and your estimated repayments to see what sacrifices you might have to make to afford the repayments. If the loan is going to put you under significant financial stress, do not take on the loan.

What help is available in Australia?

If you are struggling with debt, there are a range of services available to you.

The National Debt Helpline

By calling 1800 007 007 you can get free and confidential advice on how to manage debt with professional financial counsellors.

Or, you can visit the National Debt Helpline website for step-by-step guidance on a range of issues like mortgages, bills, and other common financial challenges.

It also offers a live chat feature to help navigate debt related problems anonymously.

Money Smart

The Australian Securities and Investments Commission’s Money Smart website provides a range of information on their website regarding debt management.

On their website you can find out how to:

• Make a repayment plan
• Access free financial counselling services
• Access legal advice in your state or territory
• Check your credit score.

Of course, speaking with a trusted friend or family member can also be a course of action when navigating financial difficulty.