Climb out of debt in 2016
The financial hangover of Christmas is rarely a mild affair, but Britons bearing the brunt of significant debts should make getting back into the black their main goal in 2016.
Debt is a rapidly expanding problem in the UK.
As at the end of September 2015, personal debt across the country had reached £1.452 trillion. But such is our fondness for spending beyond our means, the Office for Budget Responsibility now anticipates that household debt is set to reach an eye-watering £2.551 trillion by 2021.
Whether your debt is in the early stages of spiralling out of control or if you are already deep into the red, there are steps you can take to get back on track.
Don’t keep it to yourself
If your debts are keeping you awake at night, do not suffer in silence. This action in itself is often the first step and can be the source of much relief. Frank Hobson, policy and communications officer at the Money Charity, says: “Things that are hidden seem to gain a power of their own; bringing them out into the open is not easy, but it does remove the hold debt has on you. Your friends and family will almost certainly have realised that something is not quite right – they will probably be relieved to know that it is something that can be fixed.”
Face facts - deal with debt head-on
Your first port of call is to work out exactly what you owe and to whom. Then you need to triage your debts; in other words, look at which are the most urgent debts you need to pay off. In terms of a pecking order, this means in the first instance getting to grips with your secured loans, such as your mortgage.
This also includes looking at any tax – including council tax – as well as utility bills and any court fines. This is hugely important, as while you want to ensure that you keep a roof over your head, you also need to make sure you do not get hit with any fines, or worse, prosecution, which will impact your ability to earn a living.
Consolidate your debts
If you can get a loan, do so and consolidate your debts into it, as it will allow you to take better control of the situation and focus on one monthly payment. Luckily, a price war has broken out between lenders and, as a result, personal loan rates are the lowest they have ever been. For example, at the time of writing the current best buy for a £10,000 loan comes from Sainsbury Bank and M&S Bank, both of which are charging just 3.5% APR representative.
Over a 36-month term at this rate, your monthly repayments would be £292.78 and the total amount repayable would be £10,540.08. With most loans remember though, if your credit rating has gone off track, you are likely to have to pay a higher rate.
Cut back on savings and non-essentials
If debt is beginning to feel like a noose tightening around your neck, there is no point in saving, as the interest you will be earning will be nothing in comparison to the interest building up with your creditors. If you have money set aside, use it now to pay off what you can on your most expensive debts.
Look at your lifestyle, too, as there are numerous ways you can boost your ability to put more cash in your pocket and help you slash your debt sooner.
Quitting smoking, cutting back on expensive shop-bought coffees or bringing your own lunch to work could save you a fortune over the long run. In addition, get rid of luxuries such as expensive television subscriptions, as no amount of entertainment will ease the stress of having debts.
Check your credit cards
If you have managed to rack up a substantial amount of credit card debt, you are not alone. Recent research from City watchdog the Financial Conduct Authority found that more than two million people have defaulted or are in arrears in terms of their plastic spending.
However, there are a number of credit card providers currently offering 0% balance transfer deals, so if you are paying a hefty amount of interest on your current card it’s worth switching. But bear in mind the best deals are typically reserved for those with a good credit score.
Andrew Hagger, founder and director of Moneycomms, highlights while there are balance transfer deals offering up to 37 months interest free, it may not always be the best option to go for the absolute longest 0% balance transfer period if you are comfortable you can repay over a shorter timescale.
He explains: “For example, the 37-month 0% balance transfer deal from Tesco Bank comes with a one-off balance transfer fee of 2.89%, yet a 22-month 0% deal from AA has no such fee at all. For someone switching a £5,000 balance, the saving on the balance transfer fee amounts to £144.50 – so it is worth thinking about.”
Get a better utility bill
Gocompare.com highlights that by switching energy supplier, people could make significant savings as there are a range of very competitive tariffs available at the moment. Tom Lewis, director of money, life and utilities for the switching site, says: “Currently, the cheapest fixed deal on the market is the Extraenergy Fresh Fixed Price December 2016 v8 tariff, which has an annual cost of £798. Compare this to Extraenergy’s standard variable tariff, which has an average cost of £1,130.”
Switch your mortgage
If you are in the position to do so, take a look at changing your mortgage. While it is likely to be expensive to buy your way out if you are in the early stages of a new deal, if you are on a standard variable rate (SVR) you should definitely consider switching.
For example, take changing from an existing mortgage charging interest at 3.5% to a five-year remortgage best buy from Coventry Building Society at 2.34% with £999 product fee, on a £150,000 balance with 20 years’ total term remaining. At 3.5%, you would be paying £870 a month but at 2.34% it would fall to £784 a month, or £86 less a month. “Over the five-year term, the saving would be £5,160 – less the £999 fee for new mortgage, you would be £4,161 better off,” adds Hagger.
Speak to your creditors
If your situation is severe, it is essential that you speak to your creditors as soon as possible and get some free debt advice, too. Be honest, as some firms may allow you to negotiate a fresh repayment scheme – at the end of the day they are more interested in getting their money back than seeing you go under. Depending on what you owe, some companies may freeze any outstanding charges or offer you a repayment break to allow you some breathing space.
Peter Tutton, head of policy at StepChange Debt Charity, says: “Half of our clients waited over a year between starting to worry and actually taking debt advice, but trying to battle through can make the problem much worse. By being open and identifying that they are struggling, people can start to recover by taking free debt advice and speaking to their creditors.”
Consider a debt management plan
Depending on how deep in debt you are, you could consider a debt management plan (DMP), which can be helpful, especially if you have had trouble getting a consolidation loan. Firms offering these schemes will contact your creditors for you and make arrangements to help you manage what you owe, allowing you to pay off your debts at a more affordable rate.
While many debt management firms offer such a service, they tend to charge a fee, but DMPs from StepChange, for example, are free.
Freeze your debts
If your situation has become quite dire and you want to avoid bankruptcy, you could apply for an Individual Voluntary Arrangement (IVA) – a legal agreement between you and those you owe – but to get one, you need to show you have a regular income. When you take out an IVA, your debts are frozen, thereby helping you to pay them back over a set term, usually five to six years.
While you can use an IVA to pay back the likes of personal loans, credit cards and overdrafts, you cannot use it to pay off your mortgage and other debts secured against your home.
Opting for this route will naturally hit your credit score, and your rating will be affected for some six years from the date it is agreed. It may also impact your terms of employment, so ensure this route is right for you before you agree to anything.
Try to avoid bankruptcy
Bankruptcy, or sequestration in Scotland, should be your very last resort, and this route should only be taken if it would otherwise take years for you to get back in the black.
While it will wipe out your debts and give you a fresh start, your credit rating will take a battering. Your possessions, including your home, could be included as part of the deal and, again, there could be implications for your career: you cannot, for example, be a company director if you have been declared bankrupt. As such, ensure you get professional advice before agreeing to a bankruptcy deal.
Where to get more help?
If you need debt advice, there are a number of charities you can contact, including:
England: 03444 111 444
Wales: 03444 77 20 20
Scotland: Cas.org.uk/0808 800 9060
Debt Advice Foundation
0800 043 40 50
0808 808 4000
StepChange Debt Charity
0800 138 1111
Debt management plan
Not to be confused with a consolidation loan or bankruptcy, a DMP is a service offered by a specialist debt management company that will negotiate with your creditors to change the terms of how they get their money back. The debt company will renegotiate your debt repayment terms and then deal directly with your creditors on your behalf, and you then pay the debt management company, which passes the money to your creditors minus its initial and subsequent monthly fee. This can be as high as 20%, which means you’ll pay down your debts slower than you thought.
Your credit score is a three-digit number (ranging from a low of 300 to a high of 850) calculated from the information in your credit report. Your credit score enables lenders to determine how much of a credit risk you are. Basically, a low credit score indicates you present a higher risk of defaulting on your debt obligations than someone with a high score. If you have a low credit score, any products you successfully apply for will carry a higher rate of interest commensurate with this risk.
An alternative to bankruptcy, an Individual Voluntary Agreement is a legal agreement drawn up between the debtor, all creditors to whom money is owed (banks, credit cards etc) and a licensed insolvency practitioner who then administers the arrangement. Unlike a debt management plan (DMP), which is a more casual arrangement, an IVA is a legal process by which your unsecured creditors cannot then pursue you for payment of your debts outside the agreement. To qualify for an IVA, you must be a private individual (not a company), your debts must exceed £15,000 and you must have a regular income. If you are a homeowner with equity in the property, you may have to remortgage and use the equity to clear some of the debt before you enter into an IVA.
Office for Budget Responsibility
Formed in May 2010, the OBR makes an independent assessment of the public finances and the economy, the public sector balance sheet and the long-term sustainability of the public finances. The OBR has four man priorities: to produce two forecasts a year for the economy and public finances, to judge the progress the government has made towards meetings its fiscal targets, to assess the long-term sustainability of the public finances and to scrutinise the Treasury’s costing of Budget measures.
Every mortgage lender has a standard variable rate of interest, or SVR, on which it bases all its mortgage deals, including fixed and discounted rate and tracker mortgages. When special deals come to an end, the terms of the deal usually state that the borrower has to pay the lender’s SVR for a period of time or pay redemption penalties. The lender’s SVR is, in turn, based on the Bank of England’s base lending rate decided by the Bank’s Monetary Policy Committee (MPC). Every time the MPC raises its rate, mortgage lenders generally increase their SVR by the same amount but when the MPC lowers its rate, lenders are often slow to pass this on or don’t pass on the full cut to borrowers.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
This entails taking out a loan to pay off others, often to secure a lower interest rate – a fixed interest rate or for the convenience of servicing only one loan. The problem is that many unsecured loans – personal loans, overdrafts, credit cards – are then made into one big secured loan and use any property you have as collateral. Fail to pay the loan and the lender can seize your home, so it’s not for those with unstable incomes. Also, don’t be fooled that your new monthly payment is a lot less than you were paying for all your old debts: you’ll be paying off your new loan over a much longer period which, in the long run, could cost you more. Consolidation also won’t address any underlying problems you have with your finances, so reducing or combining your debt repayments may only delay more serious problems, rather than solve them.
“Arrears” tend to be associated with debt. If you fall behind and miss payments on any outstanding debt, the amount you failed to pay is an arrear – the amount accrued from the date on which the first missed payment was due.
Moving money from one account to another, whether switching bank accounts or more likely transferring the outstanding balance on your credit card to another card that charges a lower – or 0% – rate of interest. Some card providers may charge a transfer fee that can be a percentage of the balance transferred.
A person (or business) unable to pay the debts it owes creditors can either volunteer or be forced into bankruptcy – a legal proceeding where an insolvent person can be relieved of their financial obligations – but loses control over their bank accounts. Bankruptcy is not a soft option. Although it may wipe the financial slate clean, it is extremely harmful to a person’s credit rating (it will stay on your credit record for six years) and will adversely affect your future dealings with financial institutions. Bankruptcy costs £600 paid upfront.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.