Personal Debt Dos And Don’ts

Written by on September 24, 2013 in Money - No comments | Print this page

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Personal DebtThe relaxed attitude to consumer borrowing in the UK has led to large numbers of people with high amounts of personal debt.

Easy access to credit cards, store cards and bank account overdrafts has left many people feeling that their debts have become unmanageable, with more and more people filling for bankruptcy year on year in the UK.

Bankruptcy should be a last resort, as it is a public and humiliating event that will remain on your credit report for six years, and result in the insolvency of all your assets.  With a little bit of planning and determination, working out a plan to pay off your accumulated debts can help you avoid this dramatic end result.

We’ve compiled a list of dos and don’ts regarding what to do when you have made the commitment to sort out your finances and pay off your debts.

Do

Work out exactly how much you owe

This can be a nerve-wracking experience, but the sooner you do it, the sooner you can implement a damage control plan to stop the total amount of your debts growing any further.

You need to take into consideration every single pound that you have accumulated on credit cards, store cards, overdrafts, personal loans and any no-interest private arrangements you have with friends or family.

Prioritise your repayments

You should aim to pay off your existing debt that is on the highest interest rates first, and make only minimum payments on the rest.  Once you have completed paying off the highest interest rate debt in full, transfer your focus to the next highest rate, and so on.

This is important, as it makes no sense to be making only minimum payments each month on a store card with a high interest rate while overpaying on a credit card that has a very low rate – the longer debt remains on a high interest rate, the more you will have to pay in total to repay the loan in full; whereas if some of your credit exists on very low or zero interest rates, you are not increasing your debt significantly by making only minimum repayments each month while focussing on other debts.

See the example below to illustrate this:

Assume that your income available for debt repayment each month is £300

Balance Interest Rate Minimum Monthly Payment
Credit card 1 £2000 12.2%  £60
Credit card 2 £1500 10.8%  £49
Credit card 3 £250 5.5%  £15
Student account overdraft £1500 0%  £0

 

If these were your finances, your committed payments each month total £124.  This leaves £176 extra each month to pay off credit card 1.

Once credit card 1 has been repaid in full, the committed payments each month will total £64, leaving the extra £236 to pay off credit card 2.

When credit card 2 is paid, credit card 3 will be able to be repaid in full the following month, leaving all your finances to go towards reducing your zero interest student overdraft.

This process will allow you to always ensure that you are getting the best value for your money each month, and will become more and more satisfying as you tick the credit cards off on your list.

Check your finances

Although many of us may think we have our finances under control, most people would be surprised at the amount of money they are spending each month on unnecessary items.  In the rush of life, not many people examine their bank statements and credit card bills in detail each month, resulting in your money trickling away – when it could still be in your pocket!

Sit down and go through your bank statements and reassess all of your direct debits – cancel all of your non-essential direct debits to reduce your outgoings on things such as gym memberships that are never used; forgotten magazine subscriptions that are still being delivered to old addresses; and DVD rental memberships that are never used.  All this money could be going towards reducing your debts.

It is also worth checking your statements each month to ensure that no mistakes have been made, such as overcharges, failed refunds, or to be certain that no one else is accessing and using your accounts and credit cards.

Work out a realistic budget

When it comes to paying off your debts in the least time, there is no better way to work out where your money is going each month than by setting yourself a budget.  Understanding where you are overspending will help you recognise patterns in your finances and help to avoid them in future.

For example, if you leave the house in a rush every morning and grab a coffee and muffin on your way to work, this will add up to hundreds of pounds each year.  If you know that this is the case, you can create yourself a new routine where you are up earlier, eating breakfast before you leave the house.

The strictness of your budget will have to depend on how serious you are about clearing your debts, and how quickly you want to do it.  But your budget will have to be realistic enough to last – you need to be able to live comfortably and still enjoy yourself, but be aware of the fact that unnecessary spending is not going to help you achieve financial freedom.

Shift your debts onto lower interest rates

Where possible, shift your debts onto lower interest rates.  Many credit card providers offer interest-free balance transfers for a certain period.  Although you will have to pay a handling fee, moving a high rate debt onto interest free for nine months can help you pay off a huge chunk of it without the disappointment each month of seeing the interest charged on the debt.

However, it is important to pick and choose which debts are really worth transferring, as increased popularity in this habit among consumers has recently caused lenders to increase their handling fees to higher percentages, in an attempt to prevent borrowers switching freely as soon as the interest free period has ended.

It will also show on your credit report each time you make a new application for credit, which can affect your chances of success in obtaining a new interest free period.

You should also consider your debt consolidation loan options, as you may be able to secure a lower overall interest rate by rolling your debts into one large loan.

Consider your debt consolidation loan options

You should consider all possible avenues when it comes to clearing your debts.  There are so many choices available, that deciding which option best suits your circumstances can be difficult.  If you decide that a debt consolidation loan is the right choice to roll your debts into one loan, there are three main types available:

  • Secured loan – If you are a homeowner, you may want to consider the option of a secured loan, which may enable you to borrow at affordable rates and flexible loan terms.  To compare secured loans, visit our loans comparison tool to see the best rates available in the UK, and speak with a loans expert for advice regarding your personal situation.
  • Unsecured loan – an unsecured loan may be a good option, particularly if you have a good credit rating, allowing you to consolidate your debts at a competitive rate.
  • Remortgage – it may also worth looking into a remortgage if you are a homeowner with a mortgage, in order to increase your mortgage amount by releasing some of the equity in your home. To speak with an independent mortgage advisor regarding your remortgage options, complete our mortgage quote form; an advisor will contact you to discuss your remortgage options.

Speak to your lender

If you are struggling with your debt and a change in circumstances such as a new baby or loss of income means that you are missing payments on your debt, you should speak to your lender as soon as possible.

Ideally you should contact the lender as soon as you realise that you won’t be able to make a payment, as often there are options such as payment breaks that can give you a breather while you get your finances sorted out.

Don’t

Ignore it

The longer you ignore your debts, the worse they will become.  The best thing you can do is follow the steps above and begin tackling the issue today.

Keep spending

Taking steps to being paying off your debts is not an excuse to keep spending on your newly cleared credit cards.  If you have opted for a debt consolidation loan, you should cancel your credit and store cards, keeping one that is on a low interest rate; finding a debt consolidation loan may not be too difficult the first time, but if you wind up in the same position again after running up further debts on your credit cards, the second time around the debt consolidation loan option may not be an affordable option.

The author writes about personal finance topics that range from debt to insurance guides. You can read some of his posts on the blog that he maintains for Your Insurance Quote, a UK insurance comparison service.

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