Help me break free of debt
Brett Doolan, 38, is a psychiatric nurse with the NHS earning £28,816 a year.
He has recently moved into a friend's house in Worthing, West Sussex, and pays £375 in rent a month including bills. Brett is in the process of selling his family home, after separating from his wife, and has two children – eight-year-old Alyssa and six-year-old Owen.
He has total credit card debt in the region of £11,400 with Halifax, Egg and Virgin and his total minimum monthly repayments are £210.
On top of this, he has an overdraft of approximately £4,600 with Halifax and currently pays around £60 in fees plus interest each month. He will not get any equity share from the property, because it will go to his wife.
Brett is part of the NHS pension scheme and contributes £160 a month towards it. His debt built up during the breakdown of his marriage when he paid rent for nursing accommodation as well as the mortgage on the family home.
Brett now feels he is in a position to tackle his debt and is determined to resolve his situation: "I want to become debt-free, save for myself as well as invest for my children and have a little bit to play with to buy items that I need," he says.
Pete Herdman is an independent financial adviser with Skerritt Consultants in Hove, East Sussex. He says the best way for Brett to address his situation is in stages, with the objective of paying off his debts first.
"He needs to make sure he is directing his repayments to the debt with the highest interest rate first – I would expect this to be the overdraft he has outstanding. Normally bank overdrafts have the highest interest rates because they are for short-term borrowing," he says.
A big problem for Brett is that he does not know the interest rates and limits of his various debts. Herdman says the first thing he should do is find these out so he can prioritise which loan to pay off first.
Brett should also speak to his main bank (currently Halifax) to see if it can consolidate his overdraft and credit card debt into a loan with a lower interest rate.
In doing this Brett may be able to halve his interest payments each month and start to knock off more off his debt. This would also make it easier for him to keep track of his monthly repayments.
Herdman admits he may not get the most competitive rate. "However, I still believe going in with a slightly higher loan interest rate normally works out to be better than a credit card rate."
Furthermore, despite Brett's high level of debt, since he has been keeping up his minimum monthly repayments he may still have a relatively strong credit rating.
"If his current bank is unable to give him an attractive solution to help reduce his debt then I would strongly suggest he shop around on the high street to try and get a better deal," says Herdman.
He thinks it seems unfair that Halifax continues to charge Brett a fee each month, plus interest on his overdraft, without trying to help him plan to pay his debts off. Brett thinks his Virgin credit card has a promotional interest rate of 0% and that the offer runs for a further eight months.
If correct, Herdman suggests Brett transfer as much of his other credit card debt onto this card as he can, depending on his allowed credit limit. This would cut down on the amount of interest repayments he is currently paying.
Herdman feels it is important for Brett to think about what would happen if he died unexpectedly and whether he would want to leave a lump sum for his children.
Since the credit cards and bank account are in his name only, his debt would not be passed on to anyone following his death.
Through his NHS pension scheme, Brett's beneficiaries would receive twice his annual earnings as a death benefit.
Herdman says: "Brett should update his death nomination details under his NHS pension scheme, as he may have originally nominated his wife and may wish to change it now to his children.
"He may also want to look into a life insurance policy for a minimal amount, say £20 a month, to see what level of lump sum it would pay out to his children on his death," he continues.
Brett should also check with his employer to see if it offers income protection insurance, so that if he has an accident or becomes ill while working for the NHS he will continue to receive an income.
This is particularly important given his debt level and lack of savings to use as an emergency fund.
Brett could stop his pension contributions to pay off his debts quicker but Herdman advises against this. Taking a long-term view, he feels it would have a significant impact on Brett's pension provision if he stopped the contributions even for a short period of time.
"Brett is in a very good and secure final salary pension scheme with the NHS. The benefits he would be entitled to at retirement relate to his final salary and years of service – there are very few schemes which provide such generous pension benefits," remarks Herdman.
Only once Brett has paid off his debts and is in a stronger position financially is it worth him considering investing for either himself or his children.
To stop himself from getting in such an indebted state again, he should stick to a budget and build up a savings safety net of at least three months' earnings.
"Products to consider would be a regular individual savings account, a child trust fund for his younger child or possibly National Savings & Investments' Children's Bonus Bonds," says Herdman.
All of these products have preferential tax treatment and different levels of flexibility, risk and return.
Commenting on the IFA session, Brett says: "The experience has given me a sense of direction and perspective on how to tackle my debt. This alone makes it feel more manageable and less daunting or oppressive, which in turn will increase my motivation to get things repaid."
Brett's To–Do List:
1. Find out the interest rates and credit limits of his cards and overdraft
2. Approach bank for help in consolidating his debt
3. Update his death-in-service contract
4. Take out income protection insurance
Pete Herdman is an independent financial adviser for Skerritt Consultants in Hove. Visit skerritts.co.uk or call 01273 204 999.
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).
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.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
Income protection insurance
If you can’t work in the event of sickness or illness, income protection insurance aims to give you an income, with the amount of income set by you up to 75% of your gross (before tax) income with the premiums varying by how much of your salary you want to cover, as well as your age and health and when you want to start receive any payouts. Any payouts from income protection insurance are tax-free and usually continue until you recover, reach your selected pension age or the period of cover specified in the policy comes to an end. Income protection insurance does not cover redundancy but you can buy it as a bolt-on.
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.
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.