As a keen Redditor, I am always interested in the contributions from people wondering how their neighbours on similar incomes are able to live such a seemingly lavish lifestyle.
It could be that the neighbours are genuinely wealthier than they appear but a much more likely answer is that the unlikely flow of jet-skis, new cars, and elaborate overseas holidays is being fuelled by a fearless attitude toward debt and an availability of seductively available credit.
I like to call it junk debt – money that is borrowed purely to service a lifestyle that is actually well above what that household should be living and debt that is rapidly ruining their chances of a successful future.
Trinkets Depreciate While Debt Expands
While those seductive trinkets of household spending may seem attractive on the surface, they are actually a great example of rapid depreciation while on the other side of the ledger, the junk debt is mounding up at an alarming and future-robbing pace.
A recent study from financial data firm Digital Finance Analytics really blew the lid on this explosion of junk debt, showing that there are now thousands of Australian households that are literally drowning in over $1 million of credit card, car loan, mortgage and buy now pay later debt.
Rising Rates Ignite the Debt Bomb
That debt bomb will naturally be highly sensitive to the current upward moves in interest rates that are ratcheting through the financial system, hitting high risk, no reward junk debt the hardest.
Interestingly, most of these fearless junk debtors lived in middle or lower-income areas and were dominated by families who had purchased their homes more than a decade ago, often when home prices were much lower.
While some of the people in these suburbs would be travelling nicely due to the timing of their property purchase, the junk debt addicts were stuck in a constant cycle of refinancing.
No sooner has the value of their property gone up a little than they are knocking on the door of the mortgage broker or banks and refinancing so that they can buy the latest trinkets – new cars, holidays or eventually – at the tail end of the junk debt explosion – just to buy groceries.
100 Suburbs Filled with Mortgage Pain
Incredibly there are now 100 suburbs across Australia where the average household debt exceeds $1 million and another 60 suburbs where the typical household owed between $850,000 and $1million.
If they are the average numbers, some of the more extreme examples must be truly horrifying.
For some of those households the future holds bankruptcy after even the smallest bump in the road but for almost all of them the current experience is one of constant financial pain and juggling, all to keep up an outward appearance of wealth that is a total illusion.
Good Debt Versus Junk
I have no problem with people using debt constructively.
It can be a great move when used to expand your asset base and reduce the tax on your income.
However, in these cases, the addiction to junk debt is dangerously high, especially when you compare it to the still somewhat worrying average borrowing household across Australia in which personal debts total $320,000 and the average household income is around $120,000 a year.
This $320,000 includes an average of about $26,000 in consumer loans such as car loans and about $7400 in credit card or buy now pay later debt.
The rest of the debt was usually home loan or investment debt.
As Martin North, head of research at Digital Finance Analytics, put it, many of these households filled with junk debt are facing a future in which the current debt burden acts as a noose, tightening over time, particularly when interest rates rise.
“There is a segment of the population who are already cashflow negative, and for them, small rate rises will be disastrous and potentially a tipping point,” said Mr North.
He said banks will do their best to help out when hardship hits through a process he called “extend and pretend” but in the end while some will dodge an actual loan default, they won’t be able to escape the inexorable effects of compound interest working against them rather than for them.
Refinancing Increases Risk
Interestingly the rash of refinancing is turning short term financial pain into really long-term pain that will haunt the family like an unwanted ghoul.
When the refinancing happens, home owners usually consolidate their short-term debts like car loans and credit cards into their 25 or 30-year mortgages.
This might improve the household cash flow marginally and even reduce the overall interest rate a bit but it increases the overall amount of interest paid dramatically because of the greater duration of the loan.
All of which shows the perils of “using” rising home values as an excuse to live a “wealthier” lifestyle which is a total illusion and which can lead to a worrying junk debt addiction.
Unsecured Debt Explosion
That addiction is shown by the explosion in unsecured debt, with the average borrowing household now carrying about $24,000 in consumer loans and nearly $7,400 in unsecured debts including credit cards and Buy Now Pay Later (BNPL) schemes.
So, what do you do if you find yourself on this junk debt treadmill of keeping up with the Joneses?
Well, like all unhealthy habits, prevention is the real, enduring answer but in mild cases in which a portfolio of junk debt has crept up on you, I like the firehose solution.
Extinguishing Junk Debt Fires
After a painful time of reflection and slashing all unnecessary spending until the weekly budget becomes cash flow positive, this weekly surplus can then be turned into a firehose and trained exclusively on the debt with the highest interest rate.
Once that junk debt fire has been fully extinguished, the hose is turned on to the next burning debt bomb until eventually all of the high interest, personal loans are gone.
Selling many of these fast depreciating lifestyle assets might also be advisable, although maybe keeping that cobwebbed jet-ski might be a powerful symbol of a financial lesson learned and what true financial freedom is.
Short Term Pain, Long Term Gain
This process will be incredibly painful and require spending to be constrained by the tightest of straight-jackets but the pain really is the point – learning the lesson once and for all that junk debt is really dangerous but refusing to turn a short-term cash crunch into a lifetime debt addiction.
After all, rotating junk debt into your home loan is really increasing your financial risk profile.
It may be a little easier to repay every month but it is also a life sentence, with your house now on the line if anything goes wrong over the next 30 years.
Much better to extinguish the burning debt fires one by one now rather than falling further into the extend and pretend trap that leads to lifelong servitude with compounding interest your enemy rather than your friend.
