Take control of your debt
07/01/2014
Feeling as though your money (or more specifically the amount you owe) is out of control can be a frightening and often isolating experience. You are certainly not alone if you fear you have become trapped in a cycle of debt, but continuing to ignore the situation will only make matters worse. With some good advice you can get back in the driver’s seat, create a budget and start tackling your debt today.
Taking that first step towards being in control of your debt will make you feel better, and over time you will be on the road to waving those financial issues goodbye. But even if you know you want to get back on top, the idea of figuring out how and where to start can seem terrifying.
Firstly it is important to note that as everyone’s situation is different and unique to them, there isn’t a one-size fits all approach to getting out of debt. As a result, the path each person will find most useful will be the one tailored to their individual circumstances. So it’s important you do your homework and start to consider what routes there are to help take some of the stress out of your life.
For some people, it is simply a matter of taking control of your spending by doing a realistic budget, making a commitment to only spend what you have and forming a plan to pay off your debts.
For others, more specialist help is needed. If making even minimum payments on your debts means that you are struggling to put food on the table or shoes on your kids’ feet, then you really do need some expert help.
Whether you feel you need specialist help, or just a little self-discipline to get back on top of things, here are a few key principles that everyone should bear in mind.
Acknowledge that debt may be a problem
Look at your situation in all its gory detail, and be honest with yourself about any difficulties that your debts are causing. Don’t beat yourself up, but acknowledging why your debt has become a problem can also help you turn things around – maybe you have become frivolous with your spending, or you took out a loan without fully understanding the terms, or it could be that you borrowed out of genuine necessity when life took an unexpected turn.
Communicate your debt problem
Things that are hidden seem to gain a power of their own, bringing them out into the open isn’t easy, but it does remove some of the hold they have on you. Your family and friends will almost certainly have realised that something isn’t quite right – they will probably be relieved to know that it is something that can be fixed!
Start making changes immediately
Don’t put it off, start your plan today. Don’t get downhearted if you don’t get everything right straightaway – we all make mistakes, just stick with it and you’ll soon notice a big difference. It’s an old expression but ‘look after the pennies and the pounds take care of themselves’ has a lot of truth in it – a great way to start transforming your spending habits is by embracing small, simple cutbacks here and there. Would it be cheaper to get the bus instead of driving? Do you really need that coffee shop latte on your way to work? Could you spend less on groceries this week?
Reward yourself
It’s important to celebrate, not only when you’ve reached your final goal, but along the way as you eliminate each debt. Have fun with it. It can be amazingly satisfying to stop spending and gain control of your finances instead. Find free entertainment (available in your local newspaper or listings website) – make it a challenge to be frugal and save money!
How can I tackle my debts?
As with most things, it will all depend on what best works with your situation and circumstances. Everyone will be different, so make sure the path your take works for you, not your next door neighbour or best friend.
Here is a really brief overview of the major options available to help you take control of your debt. However, as with everything there is no perfect answer and quite often there are serious pros and cons of each to be aware of. Before you decide on the right route for you, ensure you are fully informed.
Everyone will be different, so make sure the path you take works for you.
Debt Management Plan
A Debt Management Plan is an agreement between you and your creditors to pay off your debts. It offers you the help you need to manage your debts and pay them off at a more affordable rate, but you have to treat all your creditors equally and therefore everyone you owe money to must be included in the plan. The arrangement tends to run over a long period of time, whereby you make a single, regular (often monthly) payment to a licensed debt management company and they then distribute the money to creditors on your behalf.
However, be aware, most non-free Debt Management Companies will charge you up-front fees and a monthly administration fee. If you do decide to get in touch with a debt management company, always make sure they are licensed by the Office of Fair Trading.
Debt Relief Orders (DRO)
If you can’t afford to pay off your debts, you can apply for a Debt Relief Order. Essentially, the order offers an alternative, cheaper option to bankruptcy, however, some of the stipulations include having: unsecured debts of less than £15,000, assets or savings of no more than £300 (e.g. you don’t own your own house) and a low disposable income. The DRO customarily lasts a year, and at the end of that period all your debts will be written off – but bear in mind you may find it difficult to open a bank account.
The Citizens Advice Bureau can give you further free, independent and confidential advice.
Individual Voluntary Arrangement (IVA)
Individual Voluntary Arrangement (IVA) is a legally binding agreement with your creditors to pay, all or part of, your debts. The IVA is based on a detailed assessment of your financial circumstances and has to be accepted by the majority of your creditors. It typically offers three different ways of repayment, including a monthly instalment plan over a fixed term (normally five years); or a short- term arrangement if you have an initial lump sum to put down; or a mixture of both.
IVAs can only be arranged through licensed insolvency practitioners (IP). Each IP is likely to vary in the amount of fees it charges and what circumstances they will accept etc, so make sure you do shop around first, to ensure you are getting the best rates. There is no point paying any more than you already have to!
Bankruptcy
Bankruptcy is a court order you can apply for if you’re not eligible for a DRO and your debts cannot be reasonably managed by another route. If you own your home, this is rarely the right choice as the property will usually be sold as part of the process. Once you have been declared bankrupt, you no longer have to deal with creditors. An Official Receiver is brought on board to take control of your money and property, and make contact with creditors.
People tend to consider bankruptcy if they are in a situation where they feel they have no money to pay off debts, or have so little that it would take them years to repay. Alternatively, someone you owe money to can apply to make you bankrupt. There is no denying that going down this route is an incredibly difficult decision to make, however there are numerous people and organisations out there that are ready to help.
If you decide to go bankrupt, you will need to apply for a court order – before you do this, try to make sure you have enough cash for day-to-day expenses as once a bankruptcy order is made, your accounts will be frozen.
It is also worth noting that bankruptcy works differently, depending on where you live in the UK, so make sure you are receiving the correct information for you.
Debt Consolidation
Sometimes the most challenging thing with unsecured debt (from personal loans to credit cards and overdrafts) is juggling numerous monthly repayments, together with different interest rates and charges. For that reason people who would prefer to deal with one monthly payment and one monthly interest rate, may decide to consolidate all their smaller debts into one large repayment. This is normally done via a Debt Consolidation Loan.
This is not for everyone and is important to be aware that debt consolidation may run the real risk of leaving you in a worse financial situation; particularly if you don’t cut up those credit cards, because you could soon end up with the loan, as well as more debt on the cards! A consolidation loan will help to preserve your credit history, but it will usually be much more expensive than a Debt Management Plan.
Savings and Debt
You will rarely be able to earn more on your savings, than you will pay on your borrowings, particularly if you are an Income Tax payer. So, it often makes sense to pay off your debts before you start to save. Equally, paying off your mortgage first, if you do find yourself in a happy situation of having some spare cash, often makes sense.
Never prioritise saving over meeting the minimum payments on your debts or your mortgage, or over the really essential things like food and electricity.
You might feel that you would prefer peace of mind and an emergency lump sum set aside as your first priority. Or it might be that you would rather maintain your mortgage at its current level and start building up a nest-egg to fund your children through university or to take that longed for trip around the world.
If you can cover the basics, then you do have some options. There is no right answer, but it helps to start to think about what works best for you and your family in your particular circumstances. Whichever route you take, make an informed decision, fully clued up on the consequences. Here are some things to consider:
•What would you do if you had an emergency? Do you have the funds set aside?
•Would you be able to borrow more money if you had to?
•Are you fully on top of your debt repayments, just keeping up with them, or falling behind?
•Do you have a specific savings goal in mind? And how important is it to you?
•Can you overpay on your mortgage without incurring an early repayment charge?
•Can you get the funds back if you need them? And how quickly?
Pay off debts with your savings….
If you had a £2,000 debt on credit card at 18%, the interest cost over the year is £360.
£2,000 in savings account earning 2% interest after tax, the interest earned is £40.
Pay off the debt and you are £320 a year better off.
There are times when debts are cheaper than savings, or have penalties to pay them off early.
1. If paying off your debts incurs a penalty, as some mortgages and loans, then it may not be beneficial to pay the debt of early. Instead, wait for the early repayment charge to expire or for the penalty to reduce to a lower amount.
2. If the interest rate on your debt is less than the amount you earn on your savings after tax then providing you have the discipline, you can profit from building up savings and maintaining the debts.
Whilst many see having an emergency fund or contingency fund as an important part of their finances, it is important that you pay off your debts as soon as possible. However, you need to be aware that if you pay off your debts, there’s no guarantee that you will be able to borrow the cash again. With credit cards, this is usually fine, as they are a source of revolving credit, but if your debt is a personal loan, then there is no guarantee you will be able to get another, in which case a contingency fund is sensible.
Need Advice?
If you need any further assistance with any of your finances, then please contact one of our advisers by asking a questions in the question box, or by phoning us on 0800 092 1245.
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