Get a budget discipline to make debt manageable
Alex Jackson, 31, is a diagnostic radiographer who lives in Newmarket in Suffolk, with his wife Lisa, 32, and their two-year-old son Noah. He earns an annual salary of £34,000 before tax while Lisa, a nurse, earns £24,000 before tax.
They have a 5.9% fixed-rate mortgage with Accord Mortgages, and repay £812 a month. Their house is worth approximately £130,000.
The couple have borrowed £18,460 across five credit cards, with Virgin Money, Barclaycard, NatWest and Capital One, and meet the minimum repayments on each card. Alex has a personal loan of £19,000 with NatWest, which costs £400 a month in repayments. He also has an overdraft and finance for a laptop amounting to £1,200.
Alex and Lisa pay £22 a month towards a joint life insurance policy with Direct Line, which is currently worth £137,000. They both have standard NHS pensions, which they each pay £150 into each month.
Their aim is to be debt-free in five to seven years. “We would like to be able to afford to have another baby, do up our house and eventually relocate to the coastal environment we love to holiday in,” Alex says.
Matthew Davison, a debt counsellor at the Consumer Credit Counselling Service (CCCS), reassured Alex that their situation is not as bad as it might seem. “I think he has been overwhelmed with the amount of debt they have collectively accrued,” says Davison.
Davison adds that theirs is a fairly common situation, and the first step is to take control of the debt. “The Jackson’s actually have more than enough income to maintain their critical position with their creditors,” he says. “If they can work out a budget and stick to it, they will be able to manage their finances a lot more effectively.”
To begin with, Davison worked with Alex to calculate the couple’s monthly income and outgoings. Each month they take home £2,943, and the total cost of their monthly essentials, including food, travel, utilities and mortgage, is £1,805 – leaving a surplus of £1,138 each month for clearing their debts.
Setting their finances out in black and white has helped paint a realistic picture of Alex and Lisa’s situation. “It was a good exercise,” comments Davison, “because it solidified the fact that they are in a better position than Alex first thought.”
However, the Jacksons had already realised that their reliance on credit was a bad situation to be in and started to change their spending habits. Davison believes this has made a difference. “If we had done the assessment a couple of months earlier, it would not have been so good,” he says.
Despite this, the Jacksons will have to work hard to clear their debts. Overall, they have £38,660 worth of debt over eight accounts. Meeting the minimum payments for each account costs the couple £868 a month. Once this is subtracted from their surplus income, the Jacksons have a buffer of £270 each month, which Davison suggests they use to make overpayments.
“They should make overpayments where they can, especially on higher interest credit cards. Making just minimum payments on credit card debt is like treading water,” he explains, adding that Alex and Lisa will be in the same position for a long time if they don’t boost their repayments.
Davison sees Alex’s loans as less of a problem because the interest is fixed, so providing repayments are kept up-to-date, they will not grow any further. Some of the credit card interest rates, on the other hand, stand at 30% APR, making them a priority to pay off.
But Davison also acknowledges that the £270 excess could be a useful financial cushion for any unforeseen expenses that crop up. “It’s important to budget ahead for those things that come up each year that can be hard to keep track of, such as car maintenance or dentist or optician appointments.”
One option Davison suggests is for Alex to look into transferring his balance to a cheaper rate credit card. While this may incur a transfer fee, it could work out cheaper in the long run, as he will pay less interest on the balance. “Like many people, Alex and Lisa fall into the trap of panicking if they haven’t saved for these unexpected costs, and then turning to more credit,” he says.
Davison is encouraged that the Jackson’s have not missed many payments on their credit cards. “The fact they have not had any registered defaults against them means their credit rating has not been tarnished,” he says.
Currently, Alex and Lisa have a fixed-rate mortgage deal, which ends in May 2011. Like many people who do not have a lot of equity in their property, the current economic downturn has plunged the Jackson’s into negative equity. So unless their position changes, they won’t be able to remortgage and they will have to stay on their current lender’s variable rate.
“This could push their mortgage repayments up considerably,” says Davison, “This means the Jacksons should also consider overpaying to increase their equity or start saving to cope with bigger repayments.”
One problem Davison identified was the bad advice Alex has received in the past. “People he has spoken to did not really go into much detail about their situation. Unfortunately, there are companies out there aiming to make money out of people in bad financial shape,” he says.
One example of this is when Alex was advised to take out an individual voluntary arrangement (IVA). This is a formal contract between a debtor and their creditors to make reduced payments over a set period (usually five years). At the end of the set period any debt remaining is written off.
However, Davison explains that IVAs are rigid, often contain high fees for the adviser, and have a negative impact on an individual’s credit rating. Furthermore, an IVA could put the couple’s property in jeopardy.
Another option Alex has looked into is consolidating their debts with a single loan. “Generally speaking, this is a bad idea,” says Davison, “It often means you end up paying interest on existing interest and in a lot of cases people find themselves paying an extra third or half over what they already owe.”
Alex was encouraged by Davison’s advice and now believes that he and Lisa can become debt-free in their time frame of five to seven years.
“Talking to the adviser was an eye-opener,” says Alex “Our main problem was an inability to budget, so we’re grateful to him for highlighting that area in particular. It was very useful.”
Matthew Davison is a counsellor for the Consumer Credit Counselling Service.
CCCS operates a dedicated freephone helpline: 0800 138 1111, open 8am to 8pm, Monday to Friday.
The circumstances in which a property is worth less than the outstanding mortgage debt secured on it. Although it traps householders in their properties, the Council of Mortgage Lenders (CML) says there is no causal link between negative equity and mortgage repayment problems. At the depth of the last housing market recession in 1993, the CML estimated 1.5 million UK households had negative equity but most homeowners sat tight, continued to pay their mortgages and eventually recovered their equity position.
An overdraft is an agreement with your bank that authorises you to withdraw more funds from your account than you have deposited in it. Many banks charge for this privilege either as a fixed fee or charge interest on the money overdrawn at a special high rate. Some banks charge a fee and interest. And other banks offer a free overdraft but impose very high charges for exceeding the agreed limit of your overdraft.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
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 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%.
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.