Diana Clement: Start getting smarter about dumb debt

Jim Carrey and Jeff Daniels were hilarious in Dumb and Dumber but the reality is a bit more sobering. Photo / Supplied

Dumb. It's a four-letter word that describes everyday things people from all walks of life do with their money.

The Retirement Commission's Sorted.org.nz website has decided to take on this collective stupidity by launching a "Dumb Debt" campaign.

Dumb debt, according to Sorted, is "high-interest debt that you could avoid. It's that unpaid credit card bill, those HPs that are no longer interest-free, and other types of high-interest debt that you could otherwise avoid".

Sorted gives the example of the purchase of a $500 iPod with a credit card, on an 18 per cent interest rate. Paying back $10 each month, it will take almost eight years to pay off and end up costing more than $930. Of that, $430 is interest.

Dumb debt makes people worse off financially and the longer they take to pay it off - an important point sometimes lost on people - the more it'll cost. Kiwis pay $650 million in interest each year on their dumb debt.

Before you turn the page, it's not just low earners who get caught in the dumb-debt spiral.

Research has shown that poor financial literacy is not restricted to any particular socio-economic group, says David Kneebone, executive director of the Retirement Commission. "There are people in lower income groups and higher income groups that exhibit the same behaviours."

Plenty of middle and higher income families are sitting on hire-purchase agreements, personal and car loans. What's more, it's anyone's guess how much interest is paid for consumer goods bought by extending the family mortgage.

It only takes a casual observer to realise that human beings are hardwired to make dumb decisions and justify them until the cows come home. Phrase what they're doing in pussyfoot language and you set them up with excuses. Saying, for example, "debt isn't good, but you're different, and it's okay in your situation", doesn't change reality. Incurring dumb debt to fuel lifestyle choices is, frankly, idiotic.

A case in point was the argument of an acquaintance of mine for buying a brand-new full-priced sofa on HP. She explained that she didn't have the cash to buy a second-hand sofa and had "no choice" but to buy on HP.

That's poppycock. Talk about justifying an unjustifiable financial decision. Unless you're actually sitting on the floor you don't "need" a replacement sofa - new or second-hand.

Most people can ask around and will find someone somewhere who has a spare couch they're happy to get rid of. Failing that, there have been some perfectly good ones going free on the side of the road in Devonport during this week's inorganic collection. Nothing a good dousing in disinfectant couldn't clean up.

If it came down to a choice between paying exorbitant HP interest for a brand new sofa, or scrounging a free one from friends and covering it with a throw, I'd do the latter.

But then interest on HP or other consumer goods loans is called "idiot tax" in our household. The phrase was coined by a debt-free 20-something relative. My children have latched on to the concept of "idiot tax" and we attach the label to all downright stupid uses of money, such as the speeding fine their father got recently.

It's very easy, of course, to sit in judgment on those less fortunate. Some people do struggle to put pot noodles on the table and have begged or borrowed the table the food sits on.

Yet middle New Zealanders can be just as dumb with money as their poorer cousins. They have higher incomes providing a greater buffer before they have the debt collectors at their door. Nonetheless, they rack up pretty dumb debt to maintain a lifestyle that some simply can't afford.

The debt mistakes of middle New Zealand are more likely to be putting a flash car - which they believe befits their status in life - on the mortgage, than buying on HP. The interest rate on the mortgage may be lower than HP or a car loan, but the life of the loan is longer, which adds up to even more idiot tax in the long run.

Equity withdrawal has become common in the past decade. As the equity in people's houses grew with increasing property prices, they saw it as money that could be withdrawn and spent.

For many, it's easier to pay for large purchases by sucking the money from the mortgage. As the Reserve Bank of New Zealand noted in a report on home equity withdrawal, these are people who don't have a savings buffer.

What passes this group of people by is that they're increasing the mortgage and indirectly paying interest on that money at the rate of their mortgage. Those increased mortgage payments, which compound over 25 years, add directly to the cost of those cars, TVs and bathroom makeovers.

Equity withdrawal allows people to delude themselves and not realise they're getting into debt in the same way that a beneficiary or low income earner is with credit card, HP and personal loan debt.

The home equity withdrawal picture has improved significantly since 2008 with Kiwis keen to ditch housing debt and not put the car or holiday on the mortgage.

It is probable that the proceeds of farm and housing equity withdrawal will eventually be consumed, although the money can be used for other purchases. In 2006 the RBNZ estimated that about 15 per cent of those withdrawals went to fund vehicle purchases.

Darryl Evans, chief executive of Mangere Budgeting Services, sees people making dumb choices with money every day of the week - although not all clients fall into this category.

Over the past two years the service has had a huge increase in clients earning between $45,000 and $85,000 and even has one family earning $188,000 that can't make ends meet. Some don't want to give up their "lifestyle" and are willing to seek food parcels.

Astoundingly, clients of the service include four accountants, as well as case managers from Work and Income New Zealand and Housing New Zealand - all of whom are supposed to be advising others on how to manage their money.

Some of those higher-earning clients make very dumb decisions indeed including one who had recently put a holiday to Fiji on the mortgage, happy to pay for it over 20 years. Another, who budgets to the last cent, still makes bad decisions. "She had bought a $3000 dehumidifier, whereas the one I have cost $450," says Evans. "She texted me to say she was feeling so great because she had paid it off. Next day she texted me again to say she'd bought a new dishwasher [on HP] because she had the money 'spare'."

This skew-whiff thinking extends to HP statements, which highlight the minimum payment people need to make on their "interest-free" and other deals. A significant proportion of people only look at that minimum payment and are unaware of how they're spiralling into debt.

Part of the problem with dumb debt is that people get their advice from the wrong sources.

More than half of respondents in the Retirement Commission's most recent Financial Knowledge Survey said they used their bank for financial advice in the previous year and 35 per cent their friends or relatives.

Both can be bad sources of financial advice. Banks are organisations that make money out of people getting into debt. Mum, Dad, and the aunties who dole out "advice" often aren't good with money themselves.

The Sorted campaign has been hitting home with some Kiwis who have posted on the Sorted Facebook page.

Kellie Mackey said: "We have always had just one HP. But every month, it sucks from money that could be saved or make life less stressful.

"Mum's words come into my head: 'If you don't have the money, don't buy it'.

"Better late than never to act upon these words."

Good on you, Kellie. Let's hope readers who have got this far aren't still making excuses or justifying their own dumb debt.