The most common financial mistake people make is to borrow money at a high rate of interest in order to buy something they don’t really need or without considering whether they could borrow at a lower cost.
This type of borrowing is what the Retirement Commission calls ‘dumb debt’ and they have launched a campaign aimed at encouraging people to get smarter with their debt. Examples of dumb debt are:
- Paying only the minimum repayment on your credit card
- Buying a large item such as a car without shopping around to find the best finance deal
- Buying on hire purchase without checking all the additional charges such as set up costs and insurance
- Being tempted by interest-free offers on hire purchase without being able to pay off the debt in the interest-free period
There is a very useful debt calculator on the Retirement Commission’s website, www.sorted.org.nz, which helps you work out the total amount of interest you pay over the period of your loan. For example, if you make a purchase of $2,000 on a credit card with an interest rate of 20% and monthly repayments of $100, you will take just over two years to pay it off and you will pay $453 in interest. If, on the other hand, you save $100 per month at 3% interest, you will be able to save the $2,000 you need within just over 19 months.
The best way to avoid dumb debt is:
- Never borrow money to buy things you don’t really need
- Always shop around for the cheapest deal on finance, taking into account the interest rate and additional charges
- Don’t borrow unless you know you can afford the repayments
- Save the equivalent of your debt repayments before you make your purchase