This is simple but for so many people the concept is something from the stratosphere. My rules are as follows:
- Don’t spend money
- Use other people’s money (a mortgage to buy property, interest free periods on a credit card) when you have to spend money
- Build your credit history (if you’re new to borrowing)
Let me explain in a bit more detail…
1. Don’t Spend Money
This is really the golden rule. Some people might choose to read this as “don’t spend money you don’t have” but see Rule #2 before you adopt that approach. But there’s no need to interpret the wording at all: just don’t spend money!
Although simple in theory, this is extremely difficult for many people to implement in practice. We’re used to spending money and our culture conditions us to spend more money than we need through marketing and advertising and by watching our friends and families succeed. Break the habit, become wealthier, spare the planet the extra plastic, and change the world, maaaaan!!! Ignore the adverts and recognise and accept your friends might be earning more money than you are/in a different financial situation to yours/stupider than you are. Spending money is not a measure of success or intelligence.
If you don’t need something, don’t buy it. Live frugally, is what I always say (rather than calling myself cheap!). Don’t live in the moment and buy impulsively. The time for spending money will come but right now you need to accumulate money and wealth and the easiest way to do this is via the magical effects of compounding, a subject on which I’ll write more about in detail another day. For now, just understand the less money you throw away, the more money you’ll have to make more money.
Before you whip our your credit card, stop and think whether what you’re about to buy is going to increase the number of days (or months or years) you’re going to have a mortgage to repay—or increase the time it’s going to take to save up a deposit for a first home loan. Ask yourself if this doodad, that beer, this seemingly insignificant expenditure is really necessary to your wellbeing and fulfilment. Can it wait another month? Another year? I remember when I first reviewed the interest costs on our PPOR mortgage: over the thirty year term, we would ultimately end up paying the bank the value of our home again. The quicker we could repay the principal, the less we’d pay on interest.
The best way not to spend money is to understand what you need to spend to survive (i.e. a plan or budget—anything), spend that amount and record the transactions against your plan or budget, and treat yourself occasionally but in moderation.
There are also many subtleties at play here. Never spend money on a depreciating asset like a car—i.e. don’t buy cars, at least not new ones, until you can genuinely afford to. Don’t buy an ultra HD curved OLED television. Don’t waste food. If you’re spending more than $50 a month on booze, you’re spending too much. Definitely don’t smoke or quit if you do. Take it easy on the holidays. Don’t eat out too much.
There are also some really easy things you can do. Buy store brand ketchup instead of Heinz ketchup. Mow your own lawn. Change your behaviours by wearing your clothes for a second season instead of refreshing your wardrobe every three months. Use grocery store fuel vouchers to save on petrol. Pay your bills on time to avoid fees. Ensure you’re never in a position where you have to pay late payment fees or, worse, credit card interest. Make your lunch and take it to work instead of buying lunch every day. Cancel your cable TV subscription. Become a vegetarian and stop eating meat. Ride a bike to work instead of catching the bus or train (or worse, driving your car and paying for parking). As you start thinking like this, you find all sorts of ways to save a few dollars and as my mom always said: “every penny counts!”
Keep the achievement of your long-term goals front of mind and what you give up today is easier to bear. We took on a $700k+ mortgage in 2006; it’s all but paid off less than ten years later through moderate (minimal, really) spending and careful saving.
Edit: Please read my follow up post “Think Rich”—it explores a valid counterpoint to this concept.
2. Use Other People’s Money
If you insist on spending money, don’t use your money, use someone else’s money—at least for as long as you can and if you can do so for free.
Credit cards are considered intrinsically evil by some people but if these facilities are not abused they can be used to your advantage. As long as your balance owing is paid by the due date—that is, you have the cash flow to afford what you’ve purchased—you won’t have any interest to pay for the privilege of borrowing that amount for up to sixty days.
We buy everything (EVERYTHING—except purchases that attract a fee) on a single credit card with a reasonable limit and we pay the credit card bill on time. Our typical credit card bills run between $2,000 and $3,000 (more around Christmas, sometimes less after a really good month); instead of being paid for immediately from our cash, the value of our monthly spend is being lent to us at no charge by the credit card company. During that interest free period, that lent money is working for us in our offset account—reducing the amount on which mortgage interest is charged.
The added bonus is having the majority of our transactions centralised on one card, which makes it easy to know how much we’re spending month to month; it’s also easy to spot any problems. I typically pay off the credit card, in full, a day or two before it’s due to maximise the credit benefit.
The key takeaway here is to never pay interest on your credit card. Most cards will charge interest at an annual rate of around 20%. This adds up to lot of money—I’m always astounded how my credit card statement tells me if I only pay the minimum amount I’ll pay off the closing balance in “58 years and 07 months” and “end up paying an estimated total interest charge of $22,828”! That’s crazy talk.
If you get stuck with credit card debt, plan on getting rid of that debt first before anything else because it will most likely be the highest interest rate you’re faced with (apart from a bad car loan, perhaps). Call your credit card company and have a chat with them about a repayment plan or an interest-free period—ask to speak to the manager if necessary. If your card company won’t help—and by help I mean be very generous to you—roll over the balance on the card to a new card with a 0% introductory balance for 12 months or whatever period you can find. Hopefully that will give you enough time to clear the debt without the interest burden accumulating on top of the original amount.
Finally, I don’t use cards that incur an annual fee just for the sake of a few perks.
When it comes to your home loan, you also need to be careful. If you have a number of debts (i.e. a car loan, credit card, personal loan, etc) you may be offered the option of consolidating all those loans into your home loan. The benefit of doing so is a better interest rate: instead of a 20% rate for your card debt, you’ll be paying 5% at today’s rates. The downside is that debt will follow you for the term of your home loan, meaning the interest on the amount you’ve consolidated will compound every year until it’s repaid—along with x number of years of interest. You could end up paying off that new car for thirty years—long after the car is gone!
You might similarly be tempted to refinance your home to free up equity for a holiday or a new toy (boat?) or a swimming pool. This is easily done but, again, be mindful that in doing so you’re hiding the true cost and using money you can’t really afford.
Credit cards and home loans are generally considered “bad debt” because it’s money that doesn’t work for you. Consider the alternative: “good debt”. This is money borrowed that you in turn use to make money through investing in real estate, a business, or stocks. In contrast to the loan on your PPOR which will cost you money on interest (this interest cannot be claimed as a tax deduction), a investment property mortgage will serve to earn you money. So as a footnote to this section, if you’re buying an investment property, use the bank’s money—secured by the equity in your home—instead of putting down your cash that can be better used elsewhere.
A student loan like a HECS debt is also someone else’s money. If you have the option to reduce interest by making early repayments, ask yourself if the cost of holding onto that loan and not making early repayments will allow you to use that money more productively elsewhere. How much will you save by making early repayments? How much do you stand to make by investing the value of those repayments elsewhere (e.g. in an offset transaction account, saving you interest of say 5% at today’s rates on your PPOR mortgage)?
3. Build your Credit History
If you’re new to property and are looking to take on your first home loan in the next twelve months or so you’re probably also saving for a deposit and implementing a lot of the tips I’ve offered above—good on you. The next step is to ensure you have some form of credit history for lenders to look at when assessing your eventual loan application. To carry on from Rule #2, the easiest way to build your credit history is to take on a single credit card, use it, and ensure it’s paid off in full by the due date. This will help identify you as a borrower with a proven track record of debt repayment—through both intention and financial means.
I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I'm learning too and expect to make many, many mistakes along the way.
Enjoy,
Michael
