10 steps to save you from drowning in debt
FACE UP TO FINANCE WORRIES BEFORE CRISIS POINT
DEBT is a four-letter word blighting millions of lives and if the Bank of England hikes interest rates tomorrow as expected, the burden is going to get worse.
Yet people need to talk about it, because that is the first step to taking positive action.
Servicing credit cards, overdrafts, personal loans and other forms of borrowing is already a struggle as the cost of living goes through the roof.
One in three people is worried about the impact higher borrowing costs will have on their mortgage repayments, while a quarter fear more expensive credit cards, according to research from Aegon UK.
The vice will tighten from April, when the new 1.25% National Insurance health and social care levy comes into force, costing the average £30,000 earner an extra £255 a year.
But the biggest mistake you can make is sticking your head in the sand and hoping your debt worries will go away. If you have money problems, the time to face up to them is today.
Interest rates are going only one way
The Bank of England looks set to increase base rates from 0.25% to 0.5% tomorrow in a bid to curb inflation, and it won’t be the last increase.
Base rates are expected to hit 1% by summer and 1.25% by the end of year. Homeowners on variable rate mortgages can expect the rise to be passed on swiftly, as happened after the BoE increased base rates in December.
Santander, Nationwide and NatWest hiked rates in a heartbeat, followed by Barclays, Lloyds, Halifax, Virgin Money and TSB.
Some 1.1 million mortgage borrowers on standard variable rates and another 850,000 with trackers paid more interest as a result.
Increasing rates to 0.5% will cost someone with a £250,000 variable rate mortgage an extra £384 a year, says Laura Suter, head of personal finance at AJ Bell. “If rates hit 1.25% then it will cost an extra £130 a month, or £1,560 a year.”
One option is to fix your mortgage now, so you lock into today’s best buy rates, she says.
Someone borrowing £250,000 on the average variable rate mortgage now could save £2,124 a year by switching to the current top two-year fix, which currently charge around 2%, Suter says.
Short-term credit costs spiral
Interest rates on short-term credit such as credit cards, store cards and overdrafts are already so far detached from base rate that a 0.25% increase will make little difference to repayments. The average credit card APR is 22.96%, according to Defaqto, while some charge as much as 34.94%.
Bank overdraft rates can hit a staggering 39.9%, Which? figures show, while Lloyds has charged some customers an eye-watering 49.9%.
Personal loan rates have climbed to 6.43%, which is the highest in more than two years.
But the following 10 steps should help you banish the D-word from
Work out where you stand
Debt can cast a long shadow over your life, so make paying it down a priority, says Jonathan Watts-Lay, director at financial advisers Wealth at work.
“Start by rounding up all your different types of borrowing and check how much each one charges.
“Credit cards and overdrafts can have rates of 18% to 40%, but payday loans can charge 1,500% and more.”
Target the most expensive
Pay down debts through a process called “snowballing”, says Damien Fahy, founder of personal finance website moneytothemasses.com.
“This involves targeting the debt with the highest rate of interest, say, a store card charging 29.9 per cent, and paying that off first,” he says. Once that is cleared, concentrate your firepower at the next most expensive debt, then the next, Damien adds.
Keep servicing your other debts
While you are taking aim at your costliest debts, remember to keep servicing any other forms of borrowing, Damien says.
“At the very least, make the minimum payments, to avoid incurring penalties or damaging your credit record.”
If you cannot afford to pay everything, you need to break them into priority and non-priority debts
(see Divide and Conquer box, top).
Overpay if you can
It will take forever to clear your debts if you simply make the minimum monthly repayment, Jonathan says.
For instance, someone who owes £3,000 on a credit card charging an APR of 18%, but who only repaid £50 a month, would take 10 years and 10 months to clear their debt. But during that time, they would pay total interest of £3,495.
“If you doubled your repayment to £100 a month, you would clear the debt in three years and four months, and your interest bill would fall to just £908,” Jonathan says.
Transfer it to a cheaper card
If you are struggling to clear your credit card bill, switching the debt to an interest-free balance transfer card could give you much-needed breathing space, says Andrew Hagger, personal finance expert at moneycomms.co.uk. “This could cut your APR from more than 20% to zero and means your monthly payments will go towards clearing the debt rather than servicing the interest.” Alternatively, consider consolidating your debts into a personal loan.
Credit cards can have rates of 18% to 40% by payday loans can charge 1,500%
Beware taking out new credit
While balance transfer cards are great if used carefully, make sure you clear the debt during the introductory period, otherwise you could be in for a shock when the APR kicks in at 20% or more, Andrew says. “You may be able to transfer it on to another balance transfer card at that point, but there is no guarantee –
especially if your credit score has suffered damage.”
Tread carefully around other forms of borrowing, such as “buy now pay later” credit from Swedish tech giant Klarna and others, says Nick Drewe, a money-saving expert at discounts platform wethrift.com.
“As with any form of credit, read the small print and make sure you know what you are signing up to.”
While BNPL allows you to defer payment for purchases for up to 30 days, at no charge, penalty fees kick in if you do not pay your debt in time.
Don’t use debt for your everyday spending
If you are resorting to credit cards to pay your rent or mortgage, electricity or grocery bills, it is a sign you are in trouble, Nick says.
Draw up a budget, separate your essential spending from the more frivolous stuff, and bring it all back into balance.
“If you’re struggling to pay a
priority debt such as your rent or your mortgage, then drop, say, Netflix or the meal subscription box you treat yourself to once a month,” he adds.
Turn credit cards to your advantage
Used carefully, credit cards can be a handy tool for managing money. You can effectively borrow for free, with no interest to pay for the first 55 days, provided you clear your balance in full each month. Set up a direct debit to make sure you don’t miss a monthly repayment by mistake. You can use plastic to repair a damaged credit score, says Jayne-Anne Ghadia, founder of money management app Snoop. “When you apply to borrow money, lenders will look at your credit history to see if you have a track record of making repayments on time. Not having any credit history can hinder your chances of getting credit,” she says.
Tesco Foundation, Vanquis Bank Chrome, HSBC Classic Credit Card
and Barclaycard Forward Credit Card can all help you prepare your credit rating. Make sure you repay the debt in full each month, as APRs are close to 30%.
Build up your financial resilience
Once you have your debts under control, start building up a cash buffer for emergencies.
This should be equivalent to three to six months of salary, ideally, to cover shock expenses such as a boiler breakdown or car repairs.
Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, says everybody should have money set aside for a rainy day.
“Set up a monthly direct debit into an easy access savings account.”
Seek help if still struggling
If you are in serious trouble, get outside help from a debt specialist, while avoiding privately run debt management plans that charge a fee for their services.
Try Government-backed guidance service moneyhelper.org, or get free help from StepChange Debt Charity or Citizens Advice.