Dealing With Debt - 9 Tips
- 29 March 2020
- 10 mins reading time
Being in debt can be stressful and expensive. In this article, we provide nine tips to help you identify, understand and address your debt.
1. You’re not alone
According to research by the Money Advice Service released in March 2016, there were more than 8 million adults in the UK who “suffer with financial worries” because of debt*. That’s around one sixth of the population.
Identifying the problem is one thing. Understanding and addressing it can seem intimidating it. But you’re not alone.
One of the ways in which you can overcome it is by choosing someone you trust, a friend or relative perhaps, with whom you can go through a small part of your finances. If that goes well, you can have a further conversation in which you go through a broader range of your assets and liabilities.
Alternatively, there are free, publicly-funded services that you can turn to including the Citizens Advice Bureau and the Money Advice Service, both of which have sections on their respective websites dedicated to dealing with debt.
2. Priority debt
Prioritising debt is essential. Not only can it help to reduce the cost of your outgoings, in extreme cases, it can help to prevent losing essential facilities such as utilities or even your home.
Top priority debts
This is where debt can become a serious and stressful issue. A list of top priority debts is held on the respective websites of the Citizens Advice Bureau and Money Advice Service. These debts can include rent or mortgage arrears, secured loans, council tax arrears and utility bills.
If you’re unable to pay these, the Citizens Advice Bureau and Money Advice Service might be able to support you in understanding your circumstances and developing a repayment plan.
Medium priority debts
The next group of debts tends to be expensive to hold but with a degree of flexibility. Credit cards, store cards and unsecured loans can be considered part of this group. If you have no top priority debts, then identify the most expensive and pressing debts that you have in this group and focus on paying those off first while maintaining the minimum on the others.
Low priority debts
If you have a government-backed student loan or a mortgage and are up to date on your payments, you can consider maintaining minimum payments on those debts while focusing extra effort and repayments on others. Student loans tend to be issued on very favourable terms with low interest rates and repayments only required after you’ve reached a designated level of income.
A mortgage can also have a positive role to play, providing a place to live and, if you are repaying the capital, contributing to the proportion of your home that you own. But it’s still worth checking to see if you can get a mortgage on a lower rate of interest. You need to be sure that you’re not going to be penalised with early repayment charges, and you’d be wise to ensure that you are dealing with a reputable mortgage provider who will help to find a deal that works for your unique circumstances. Remember that applying for new credit or borrowing will affect your credit rating.
3. Clear the most expensive debt first
This is an easy win, so to speak.
Imagine you have three credit or store cards. List the interest rate you’re being charged on each. This might be 25%, 20% and 15%. Whichever is charging the highest rate of interest is the one to clear first.
If you don’t do it in this order, you could end up paying more interest charges for longer than you might have needed to.
For example, while you continue to make the minimum payments on the other two cards, you could make overpayments on the most expensive one. It doesn’t matter if that card has the least or the most amount borrowed on it. It’s costing you the most per pound borrowed and should be dealt with first.
Once you’ve cleared the most expensive one, move on to the next most expensive. This should create a snowballing effect: as the total debt and average interest rate comes down, the money you’re using to pay your debt down should eradicate a bigger and bigger proportion of the debt.
4. Consider using savings to clear debt
It can be tempting to keep some cash or savings aside as a sort of nest egg. If you’ve cleared your debt, this can make sense. But if you still have debt, keeping a cash nest egg could be costing you money unnecessarily every month.
Here’s an example:
Imagine you have £1,000 on credit cards, charging an average interest rate of 15%.
You also have £1,000 in a savings account earning 2% a year.
That means you’re paying at least £150 a year in interest on one hand while earning £20 a year before tax on the other.
The feel-good factor of having a nest egg is costing you £130 a year, and that’s not allowing for any tax that may be due on the interest payments or higher interest rates on credit or store cards.
The same principle works if the savings and debt don’t match. For example, £500 in savings could halve your debt of £1,000 and reduce your annual debt payment by £75, making it easier to repay the remainder.
You must take into account whether or not you can withdraw the savings with little or no financial penalty. Depending on how much that would cost, it might make sense to use it to pay off as much medium- and top-priority debt as you can as quickly as possible.
It should be noted that this entire consideration becomes more complex if you have longer-term investments. That’s where your wider personal circumstances should be taken into account, and it would be wise to take professional financial advice before making a decision.
5. Replace expensive debt with cheaper debt
This can make the whole process of debt clearing considerably more manageable. However, you must have some self-discipline.
Two ways of doing this could be to consolidate your expensive borrowing into a cheaper loan with a reputable bank or building society. Alternatively, you might be able to transfer money from an expensive credit card to a cheaper one, but you’d need to keep an eye on the transfer charges and time limit on the interest-free offer.
In either case, there is a golden rule: once you’ve cleared your expensive credit cards, don’t use them again. It might make sense to close the accounts completely as that removes the temptation to use them for non-essential purchases. Reducing the number of credit cards and loan facilities you have (even if you’re not using them) also can improve your credit rating.
Even when you’ve cleared all of your debt, it can make sense to keep one low-interest credit card tucked away at home somewhere to use in the case of a real financial emergency (e.g. medical costs or repairing a leaky roof).
6. Clear the entire balance each month
If you do have a credit card, have self-discipline. Otherwise, should you have a credit card? Clear the debt in full each month. If you’re unable to do this, then you might be spending beyond your means…time to make a budget and retake control.
7. Are you prepared for the unexpected?
If you are debt-free, it can make sense to keep a limited amount of cash, or savings that can be accessed quickly in case of an emergency. That said, cash is usually being eroded by inflation, so you need to have a balanced approach to holding cash.
8. Budget – don’t be intimidated by this!
A budget can reveal some home truths that you can address, enabling you to control your money rather than it controlling you.
A simple example might be that you’re buying two coffees from one of the well-known coffee chains every weekday. That adds up to around £100 a month (£2.50 x 2 = £5 a day i.e. £25 a week). Using a bag of coffee to make your own coffee means you still get the drink without landing in it.
9. After debt is cleared, focus on growing your investments
Once you have a budget you can start to plan. Some of the questions you need to ask include:
What is your net worth? (everything you own minus everything you owe)
What lifestyle would you like to aim for in five years’ time?
How much of a pension would you need to meet your retirement lifestyle?
What would you like to provide for your loved ones? (e.g. education, travel)
With these thoughts in mind, you’re in a better position to create a financial strategy to help create the life you want to live.
*Source: “One in six adults struggling with debt worries”, Money Advice Service, 10 March 2016
Any views expressed are our in-house views as at the time of publishing.
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