Money Answers: how to handle debt during a split

BusinessDesk's investments editor, Frances Cook, responds to readers' emails on a weekly basis to answer questions about money. Below you'll find her expert advice. Send your own questions to [email protected].

Hi Frances,

I'm sure you see this kind of thing all the time but I'm keen to get a second opinion as I always seem to make the wrong decision. 

My partner and I are in the process of splitting up (not married) but we have a toddler and a hefty mortgage, which means we are currently stuck living together. Neither of us can afford it on our own and splitting and selling means we have to both move into town an hour away from our work and daycare to be able to afford somewhere (we live in rural Northland). 

I have quite a bit of consumer debt (loans, credit card, car payments) and my tax refund is going to get rid of about a third of it. 

Should I use the extra money from repayments I don't have to pay any longer (about $1,000 per month) to get rid of the other debts more quickly, to be in a better position for mortgage 2, or save it towards fixing up a few things around the house to make it more appealing before I move out?

I haven't got much in savings, apart from KiwiSaver (which I already used to buy the current house) and some in Sharesies, because I pay most of the bills and have consumer debts.

Thanks,

L

Hi L,

Sorry to hear about the split. Even when you know it’s the right thing for everyone, it certainly can make life tough. 

In this situation, I suspect that paying off as much debt as you can, as quickly as you can, is the best option. So, that’s great news that your tax refund is giving you a helping hand. I would make it a priority to pay off the rest now, and here’s why. 

Interest rates have been going up, which means all forms of debt are becoming more expensive. All the signs are that interest rates are going to keep going up in the future, as well. 

Time equals money

Time is always money when it comes to paying off debt. The faster you can pay it off, the less you end up paying overall. 

If you pay a dollar extra now, you’re not just saving that one dollar, you’re saving every dollar in interest and fees that it would have cost you. 

It depends on the interest rate you're paying, but one dollar in extra payments on something like a car loan can often save you paying about three dollars later.

But 'time is money' is a saying that's even more true now, with the threat hanging over you of debt becoming more expensive.

The Reserve Bank sets interest rates in New Zealand, and it's given us plenty of signs that it plans to just keep yanking them upwards. 

So, the debt you have now might be as cheap as it will ever be, and the easiest to pay off now. You have a chance to pay back more of the debt itself, without constantly having to spend your money on higher interest and fees. 

In other words, paying off as much as you can now is likely to be easier now than it will be in six months. 

Play nice with the bank

The other reason I recommend this step is that you’re considering buying a new place and you'll be applying for a new mortgage. Banks are being very picky about mortgages at the moment and one big thing they hate is other forms of consumer debt. 

Having debt, particularly credit-card debt and the like, means they reduce how much they’ll offer to lend you for a mortgage. 

This factor has a seriously oversized impact. 

It changes from bank to bank, but generally, they’ll cut six times your debts off the size of the mortgage they'll offer you. 

So, if you have credit card debt of $10,000, that could mean you'll be offered $60,000 less for a home loan than you would have been given if you didn't have debts. 

Debt tactics

If you’re looking for ways to pay your debts off faster, I suggest going for either the snowball or avalanche methods. 

If you avalanche, you pick the debt with the highest interest rate and focus all your extra payments on that until it’s gone. Then you pick the next highest interest rate, and so on. 

This will save you the most money overall, and clear your debt the fastest. If you were a robot, it would be the only way to do it. 

However, we’re not all robots! So, if you’re someone who needs a bit of motivation and success to help you keep going, we have the snowball method. 

When you snowball, you pick the smallest debt overall and focus all of your extra payments on it until it’s gone. Then you pick the next smallest, and so on. 

This means you get a quick hit of success and a reminder that you can do this. 

There’s no true right or wrong way to pay off debt; the best way is the one that works for you. However, I would say that in this money environment, you definitely want to get rid of that debt as quickly as you can, whichever way works for you. 

That sweet feeling of freedom will be a big reward once you get there. 

Home-seller secrets

You are thinking of making your house more appealing before you sell. I obviously haven’t seen your place and don’t know if it needs much work. 

However, I’ve talked to plenty of real estate agents, house flippers, and other real estate industry types, and I can give you a general idea of what makes the biggest difference to selling your house. 

People tend to overestimate how much they can make back on big improvements to the house. Things like a new kitchen and bathroom may cost you quite a bit, and not get you much extra in the eventual house sale. 

The cheap things are actually what tend to make the most difference. For example, a couple of touch-ups of paint here and there, only where really needed (if your toddler has redecorated a couple of your walls, say). 

Otherwise, the biggest change to sale price can be … a thorough deep clean and decluttering. This one is free and can mean a difference of tens of thousands of dollars. I’m not joking. 

You might want to ask friends if you can store some things with them while you have the house on the market. Then go through and declutter everything you can – the extra chair in the living room, the pile of toys, the overstuffed medicine cabinet. 

Stash it elsewhere, and space out what’s left. Then scrub the house to within an inch of its life. 

You’ll be amazed how much more spacious it feels – brighter, and lighter. These are things that a lot of buyers are looking for. 

This is the number one thing real estate agents tell me they wish sellers would do, but a lot of them dismiss it because it seems too easy, and they can't see that it would have a big impact. 

Take the easy win, and go for the free upgrade. 

As a side note, I talked to another reader a few weeks ago about financial issues to consider before a split. 

While you’re not getting a divorce, there are a lot of similarities when you’re trying to detangle a long-term relationship. So, I’m linking that previous letter here in case it can also help you. 

All the best, I hope the move goes well. 

Get more tips for paying off debt in this episode of the Cooking the Books podcast:

Send questions to [email protected] if you want to be featured in the column. Emails should be about 200 words, and we won't publish your name. Unfortunately, Frances is not able to respond to every email received, or offer individual financial advice. 

Information in this column is general in nature, and should not be taken as individual financial advice. Frances Cook and BusinessDesk are not responsible for any loss a reader may suffer.