Work off your debts
If you've managed to get your finances in order and produce a manageable budget (see Slim down your finances) you should now have a better idea of where you stand financially and be in a position to tackle any unsecured debts lurking on credit cards, personal loans or in overdrafts.
Most people have debts in one form or another because in our credit-obsessed society it has become more and more acceptable to buy now and pay later.
However, this attitude to spending can quickly escalate out of control and more than eight million Brits have unsecured debts of £10,000 or more, according to debt consultancy Thomas Charles, with over two million finding it difficult to repay them.
"We have seen a sharp increase in the number of people who have taken on unsecured debt and are now struggling with repayments," says James Falla, director of Thomas Charles.
Many people are only just managing, which means that a change in circumstances, such as being made redundant, would tip them over the edge.
Citizens Advice reports that more and more people are struggling to meet their day-to-day living expenses. But the worst thing you can do if you have debts is to bury your head in the sand and pretend they don't exist. You have to face up to them and tackle them head on.
How much do you owe?
The first step is to work out exactly how much you owe, says James Ketchell, a spokesman from debt charity, the Consumer Credit Counselling Service (CCCS). "Sit down with your all statements and bills and actually open and read them," says Ketchell. "Note down the amount you owe to each creditor so you can clearly see the level of your debt."
The next step is to prioritise your debts to maintain payments on the most important ones. "Your mortgage payments and council tax should always take priority because failure to pay these could result in your home being repossessed or being taken to court," adds Ketchell.
If you're having problems meeting your mortgage payments, either due to the interest rate rises or a change in your personal circumstances, it is imperative to speak to your lender. If your mortgage has flexible features, as many products now do, it may be possible to come to an arrangement that allows you to stop repayments for a few months until you get back on track.
Next, jot down the interest rate charged on each debt and aim to pay off the ones with the highest rates first. Store cards are notoriously expensive so these should be prioritised to clear quickly and then cut up so you cannot use them again. Credit cards can also be very expensive, with some charging rates of up to 18%. On a credit card balance of £1,500, this will add an extra £270 a year in interest alone.
Wherever possible, see if you can switch debts on costly cards to one that offers 0% on balance transfers. This will ensure your repayments actually chip away at the debt rather than being swallowed up by interest. However, James Falla warns not to use this as an excuse to run up more debt elsewhere. You shouldn't be spending on these cards so keep them at home, not in your wallet.
Reduce your repayments
If you have a personal loan with a high interest rate, it may also be possible to refinance the debt with a cheaper loan in order to reduce the size of your repayments. Some personal loans have eye-watering rates as high as 30%, which would add a whopping £8,151 in interest to a £10,000 loan repaid over five years.
You don’t need to be paying anywhere near this much and shopping around for a good deal may turn up some pleasant surprises.
It’s important to check with your current lender first though, because some charge early repayment penalties if you want to pay it off before the end of the term.
A low-cost personal loan can also be used to consolidate your debts, but think carefully before you borrow any more. Your priority should be clearing your debts not shifting them elsewhere. Secured or homeowner loans are also touted as a great way of consolidating your debts but they are best avoided.
By securing a loan to your home the roof over your head is at risk if you struggle to meet repayments. And, even though monthly repayments may be reduced, your loan is likely to be stretched over a much longer period of time, so you pay much more in the long run.
Although they are often viewed as simply an extension to our current account, overdrafts are also an expensive form of debt and some banks charge up to 20% AER for being overdrawn. The average overdraft among Brits is £677, according to uSwitch.com, which could grow by up to £135 a year if you don't tackle it.
If you are reliant on your overdraft make sure you keep a close eye on your balance. Debts can become exacerbated by unauthorised overdraft fees of up to £39 that are levied by banks each time you exceed your agreed limit, often just by as little as £1. Aim to clear your overdraft as a priority and ask your bank to reduce your limit so you are not tempted to slip into it again. Alternatively, consider switching to a current account that offers a free overdraft.
If in doubt, seek help!
If, after prioritising your debts andproducing a budget, you are still struggling to meet the repayments on your debts or they account for more than 25% of your take home income, you should seek professional help.
The first step before considering options such as an IVA (individual voluntary arrangement) or bankruptcy, is to speak to a debt charity, such as the CCCS (0800 138 1111) or the Citizen's Advice Bureau. Always speak to a charity over the debt consolidation firms that are often heavily advertised during daytime TV, because charities will provide completely free and impartial advice for your personal circumstances.
If your debts exceed £15,000, an IVA is a less restrictive alternative to bankruptcy. This is basically a legal contract between you and your creditors to repay a percentage of the debt over the life of the IVA - usually five years. The IVA will be supervised by a licensed insolvency practitioner, and the idea is that you reach an agreement with your creditors to avoid the consequences of bankruptcy.
Unlike with bankruptcy, you won't have to surrender your home or business with an IVA, but you may have to release some equity at the end. Nor will your financial difficulties be made public in the local press and London Gazette as they are if you are declared bankrupt. You may, however, have to cash in any releasable assets like endowment policies and any other savings or investment plans.
When, and only when, you have cleared your debts, can you redirect your monthly payments towards starting a healthy savings habit instead.
Generally speaking, insolvency is to businesses what bankruptcy is to individuals. A company is insolvent if the value of its assets is less than the amount of its liabilities, or it is unable to pay its liabilities (loan payments) as they fall due. It’s an offence for an insolvent company to keep trading, so the main options available to an insolvent company are: voluntary liquidation, compulsory liquidation, administration or a company voluntary arrangement.
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.
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.
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.
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.
Where APR is the rate charged for money borrowed, Annual equivalent rate is how interest is calculated on money saved. The AER takes into account the frequency the product pays interest and how that interest compounds. So, if two savings products pay the same rate of interest but one pays interest more frequently, that account compounds the interest more frequently and will have a higher AER.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.