Avoid the mid-life crisis

Brett Schatto from Pride Advice contributed to the Money Magazine November 2019 Edition cover story on debt management. Read an extract from the article below or check out Brett and Tony’s chat about the article on the video “Strategy Session – Managing the Debt Trap

This time of life is typically the consolidation and growth phase of your wealth-creation journey. At this stage, it’s important to have a multi-pronged approach that includes strategies to reduce your debts and at the same time grow your assets.

“Reducing your debt may look appealing as it delivers a risk-free and often tax-effective benefit to your financial position,” says Pete Pennicott, a director and financial adviser at Pekada. “But that is only half of the story. In the extremely low interest rate environment, you need to consider the opportunity cost of debt reduction versus investing into growth assets which, over time, have proven to deliver greater returns than mortgage rates.”

Having funds sitting in an everyday bank or online savings account is rarely the best option if you do have debts. This is because the earnings rate is generally lower than your loan interest rate and is also subject to income tax.

“A better use in most cases will be to hold the funds in an offset account, which reduces interest payable but still provides at-call access to the funds. An offset account is really a no-brainer if you have a home loan, as it is a simple and risk-free way to make your loan payments go further,” says Pennicott.

In a falling interest rate environment a good piece of advice is to maintain your loan repayments at their current rate even when the minimum amount is reduced due to lower interest rates. This means more of your payment goes towards reducing the loan’s principle and accelerating your path to becoming debt free.

It’s also important to acknowledge that it can be difficult to reduce debt and save at this time of life because there are many demands for your money. Your 40s and 50s are also likely to be the years when you’re saddled with the most debt thanks to a mortgage on your home. “You may need a bigger home as your kids get older. Then, there are all the additional out-of-pocket expenses such as the cost of running a second car to get the kids to sport, laptops and school equipment, mobile phones, clothes, parties and holidays.

“It’s easy to lose track of spending and take your eye off your goals during this stage. So it’s important to ensure your retirement savings are working efficiently at this stage,” says Brett Schatto, chief executive of Pride Advice in Adelaide.

These years are also the ultimate income-generating years if you have worked hard and are at the peak of your working life potential. This means it’s critical to have a plan for these years to make sure you maximise every dollar to help you on the road to financial independence.

“Regularly review your mortgage repayments. And if you’re keen to invest, ensure you pay off any bad debt first,” says financial planner Gianna Thomson.

Good debts are investment debts that are tax deductible, particularly where the growth and income from the investment are more than the cost of debt. Bad debt includes consumer debt such as credit cards, buy now, pay later services and personal car loans.

Depending on your circumstances, you may feel comfortable forgoing higher debt repayments to focus on salary sacrificing into your superannuation fund. This reduces your income and tax payable.

“If this is the approach you choose, a taxfree lump sum could be withdrawn from your super when you retire to pay off your mortgage,” says Thomson. It’s also important to recognise that illness and injury can be a problem for this group. “If you don’t have personal insurances in place, people often use their credit card or redraw to fund medical expenses,” says Thomson.

To avoid this situation, ensure you have the right income protection and trauma insurance in place early in life. If you do fall ill, an option may be to reduce your repayments by switching from a principle and interest to interest-only mortgage.

Try to avoid getting into debt to pay school fees during these years. Thomson says her son was born in September this year and he already has an education fund. One idea is to use online calculators that help with estimating the cost of private schooling or university and how much you need to save or invest every month.

During these years, another option may be to use the equity in your home to free up cash flow that can be allocated to debt-recycling strategies such as converting the equity from the main home into a line of credit. This may be applicable for people who have paid off half or more of their home loan.

“This may be an efficient way of creating a productive asset such as an investment portfolio. Surplus cash flow or savings are used to reduce the outstanding home loan balance, reducing non-deductible debt and converting this into tax-deductible debt,” says Mike Lawson, from About the Goal Financial Solutions.

“This process can continue until the home loan is repaid. When this is done, surplus income can be used to acquire additional investments or pay down the investment loan.

The middle life years can also be when the risk of “sexually transmitted debt” – debt you catch from your partner – is highest.

“It’s not necessarily malicious, but the end result, whether or not the relationship has ended, is you can end up with debt simply from being in that relationship,” says FinFit’s Donna Sgangarella.

“Sexually transmitted debt can be long lasting and very damaging. Communication is key between partners. You need to openly talk about your finances and ask this simple question: what would happen if everything was to go wrong?