Dealing with debt

When it comes to taking control of your finances, one of the most important steps is dealing with any debts you owe.

The first thing you need to ask yourself is: am I in problem debt?

There’s no strict definition of problem debt. But here are some questions to ask yourself to help you decide if your debt is becoming a problem:

• Are you using balance transfer options and refinancing, rather than paying off your debt?
• Do you always seem to be making minimum payments?
• Are minimum payments taking up a large proportion of your expenditure?
• Have you got debts with collection agencies?
• Do you use credit to buy regular, everyday items?
• Does thinking about your debt or debt repayments leave you with a sinking feeling in the pit of your stomach?

If you answered yes to a few of those – especially the last one – then it may be time to get some debt advice.

That doesn’t necessarily mean you need to start a debt solution – simply chatting through your budget with a specialist, one-to-one, could make a world of difference. If you’d like to speak to one of our experts at Financial Wellness Group either call 0161 413 4782 or visit our website for more details – including how to webchat with an adviser. Or, if you prefer, you can visit the Money Helper website to find sources of free debt advice.

However, not all debt is problem debt. In fact, most debt isn’t! Lots of us have debts as part of our everyday lives – an overdraft, credit cards, a car on finance – without it ever being a problem.

But it’s still important to make sure you’re in control of your debts. That way you can be sure that you’re not spending more on debt repayments than you have to. And if your circumstances change – for example, if your income goes down, or your living costs go up – you won’t be stuck with more debt than you can afford.

So let’s take a look at what you owe, and how you’re paying it off.

 

How much do you owe?

On the third tab of our budgeting spreadsheet there’s space for you to make a note of all your debt repayments: credit cards, loans, Buy Now Pay Later, arrears on any household bills, and so on. Make a list of:

• how much you owe
• to whom
• the Annual Percentage Rate (APR), which is the total interest cost over a year – it will show this on your statement
• and how much you’re paying off each month.

If you use an overdraft, you may not be paying it off regularly, but it’s still a debt – make a note of how much of your overdraft(s) you’re using, and what the APR / interest rate is.

If you have a mortgage, that’s a debt too – but it’s different from most other debts in a lot of ways. We’ll get to that later.

 

Prioritising

Many of you have told us that your goal for the Budgeting Bootcamp is to begin saving money. But if you have debts, it usually makes more sense to pay them off before you begin saving.

That’s because the interest you’re paying on your debts is almost certainly more than the interest you’re earning on your savings.

There are a couple of exceptions:

• If your debt is designed to be long-term – like a mortgage – then it usually doesn’t make sense to pay it off early, because you’re likely to pay a penalty if you do. (If you’re getting close to the end of your mortgage term and you’re wondering whether it might be an option to pay off your mortgage with savings, give your provider a call to discuss your options.)
• If your only debt is at 0% interest – for example, if all of your debt is on balance transfer cards – then it could make sense to save money while making only the minimum payments on your cards. You can then put those savings towards paying off any remaining balance on those cards when the promotional 0% interest period comes to an end.

In most other circumstances, you should prioritise paying off your debts. That said, you may decide that it makes sense for you (or just feels more comfortable), to build up some savings even whilst you are repaying debt – because the savings will give you a buffer to help you deal with any future unexpected bills or spending without borrowing more. So allocating money both to reducing what you owe and some to saving isn’t necessarily wrong! Read our guides to building a savings habit and to setting savings goals to help you get started.

Arrears on any priority bills should come first though. That’s because if these aren’t paid, there can be serious implications, including having services such as gas and electricity cut off, having your home repossessed, being made bankrupt or even going to prison.

The most common priority debts are:

• Arrears on a mortgage or other loan secured on your home
• Rent arrears
• Court fines
• Council tax or overpaid council tax support
• Government debts (ie underpaid tax or overpaid benefits)
• Child Maintenance
• Arrears on utility bills
• Car payments
• Any hire purchase agreements.

Once you’ve dealt with any priority debts, it’s time to decide how best to pay off your remaining debts.

Some people recommend an approach called the ‘snowball method’. Here’s how that works:

• Start with your smallest debt. So let’s say you owe £500 on one credit card, £200 on another credit card, and a £1,000 loan: you’d start by focusing on the £200 credit card.
• Pay as much as you can off the £200 credit card each month.
• In the meantime, keep making your contractual monthly repayment on your loan and the minimum payment on your £500 credit card.
• When the £200 credit card debt is paid off, switch to your next smallest debt and repeat.

The snowball method works for some people, because it can seem daunting to address all of your debts at once – starting with the smallest debt can make it seem more achievable to deal with your debts.

However, it’s not the most cost-effective way to deal with multiple debts.

An alternative method – one that is likely to save you money in the long run – is to start with your most expensive debt.

• Taking the examples above, let’s say you owe £500 on a credit card with an APR of 40%; £200 on another credit card with an APR of 20%; and £1000 on a loan with an APR of 10%.
• You’d start by repaying as much of the £500 credit card debt as you could afford each month, while maintaining your contractual minimum payments on your other debts.
• Paying more than the minimum off your most expensive debt means you’ll pay less in interest in the long term. You can see the benefits of making more than minimum payments each month by using this calculator from Money Helper.

We hope this has been a useful overview of how to deal with your debts. If you need more advice, you can speak to one of our experts at Financial Wellness Group. Just call 0161 518 8285 or visit our website for more details – including how to webchat with an adviser.

Or, if you prefer, you can visit the Money Helper website to find sources of free debt advice.