Ten steps to avoid drowning in debt as the cost of living soars
Debt is a four letter word that destroys millions of lives and if the Bank of England raises interest rates tomorrow as expected, the burden will get worse.
Yet people need to talk about it, because it’s the first step to taking positive action.
Servicing credit cards, overdrafts, personal loans and other forms of borrowing is already difficult as the cost of living soars.
One in three people are worried about the impact higher borrowing costs will have on their mortgage repayments, according to research by Aegon UK, while a quarter fear more expensive credit cards.
The noose will tighten from April, when the new 1.25% National Insurance health and social care tax comes into force, costing the average £30,000 earner an extra £255 a year.
But the biggest mistake you can make is sticking your head in the sand and hoping your debt worries will go away. If you have money problems, now is the time to deal with them today.
Interest rates only go one way
The Bank of England looks set to raise its key rates by 0.25% to 0.5% tomorrow in an effort to rein in inflation, and it won’t be the last increase.
Base rates are expected to reach 1% by summer and 1.25% by the end of the year. Owners of variable rate mortgages can expect the hike to pass through quickly, as happened after the BoE raised base rates in December.
Santander, Nationwide and NatWest raised rates at a glance, followed by Barclays, Lloyds, Halifax, Virgin Money and TSB.
Some 1.1 million standard variable rate mortgage borrowers and another 850,000 with trackers paid more interest as a result.
Raising rates to 0.5% will cost someone with a £250,000 variable rate mortgage an extra £384 a year, says Laura Suter, personal finance manager at AJ Bell. “If rates hit 1.25%, it will cost an additional £130 a month, or £1,560 a year.”
One option is to settle your mortgage now, to secure yourself the best purchase rates today, she says.
Someone borrowing £250,000 on the average variable rate mortgage could now save £2,124 a year by switching to the current two-year rate, which currently charges around 2%, according to Suter.
Short-term credit cost spiral
Interest rates on short-term loans such as credit cards, store cards and overdrafts are already so far from the base rate that a 0.25% increase will have little impact on refunds. The average APR for credit cards is 22.96%, according to Defaqto, while some charge up to 34.94%.
Bank overdraft rates can reach a staggering 39.9%, which? the numbers show, while Lloyds charged some customers a whopping 49.9%. Personal loan rates climbed to 6.43%, the highest in more than two years.
But the following 10 steps should help banish the D-word from your household.
1 Determine where you are
Debt can cast a shadow over your life, so make it a priority, says Jonathan Watts-Lay, director at Financial Advisors Wealth at work.
“Start by rounding up all your different types of loans and checking how much each charges.
“Credit cards and overdrafts can have rates from 18% to 40%, but payday loans can charge 1,500% and more.”
2 Target the most expensive
Pay off debt through a process called “snowballing,” says Damien Fahy, founder of personal finance website moneytothemasses.com.
“It involves targeting the debt with the highest interest rate, say a store card charging 29.9%, and paying it off first,” he says. Once that’s settled, focus your firepower on the next most expensive debt, then the next one, adds Damien.
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3 Continue to pay off your other debts
While you’re aiming for your most expensive debt, remember to keep paying off all other forms of borrowing, says Damien.
“At the very least, make the minimum payments, to avoid incurring penalties or damaging your credit report.”
If you can’t afford to pay it all off, you should split it into priority and non-priority debt (see the Divide and Conquer sidebar, above).
4 Overpay if you can
It will take you forever to clear your debts if you just make the minimum monthly repayment, says Jonathan.
For example, someone who owes £3,000 on a credit card charging an 18% APR, but only pays £50 a month, would take 10 years and 10 months to clear their debt. But during that time they would pay a total interest of £3,495.
“If you doubled your repayment to £100 a month, you would wipe out the debt in three years and four months, and your interest bill would drop to just £908,” says Jonathan.
5 Transfer it to a cheaper card
If you’re struggling to pay your credit card bill, switching debt to an interest-free balance transfer card could give you some much-needed respite, says Andrew Hagger, personal finance expert at moneycomms.co.uk .
“This could reduce your APR by more than 20% to zero and means that your monthly payments will go to clearing debt rather than paying interest.”
You can also consider consolidating your debts into a personal loan.
6 Beware of new credit
While balance transfer cards are great if used carefully, be sure to clear the debt during the introductory period or you could be in shock when the APR kicks in at 20% or more, said Andrew.
“You may be able to transfer it to another balance transfer card at that time, but there’s no guarantee – especially if your credit score has been damaged.”
Watch out for other forms of borrowing, such as Swedish tech giant Klarna’s “buy now, pay later” credit and others, says Nick Drewe, a money-savings expert at discount platform wethrift .com.
“As with any form of credit, read the fine print and make sure you know what you’re getting into.”
While BNPL allows you to defer payment for purchases for up to 30 days free of charge, penalty charges kick in if you don’t pay your debt on time.
7 Do not use your debts for your daily expenses
If you’re resorting to credit cards to pay your rent or your mortgage, your electric or grocery bills, that’s a sign you’re in trouble, says Nick.
Set a budget, separate your essential expenses from the more frivolous things and rebalance everything.
“If you’re struggling to pay a priority debt like your rent or your mortgage, then skip, say, Netflix or the meal subscription box you treat yourself to once a month,” he adds.
8 Turn credit cards to your advantage
Used with care, credit cards can be a handy tool for managing money. You can actually borrow for free, with no interest to pay for the first 55 days, as long as you pay your balance in full each month. Set up a direct debit to make sure you don’t miss a monthly repayment by mistake.
You can use plastic to repair a damaged credit score, says Jayne-Anne Ghadia, founder of financial management app Snoop.
“When you ask to borrow money, lenders will look at your credit history to see if you have a history of paying back on time. Not having a credit history can hinder your chances of getting credit,” she says.
Tesco Foundation, Vanquis Bank Chrome, HSBC Classic Credit Card and Barclaycard Forward Credit Card can all help you prepare for your credit rating. Be sure to pay off all debt each month, as APRs are close to 30%.
9 Build your financial resilience
Once you have your debts under control, start building a reserve of cash for emergencies.
This should amount to three to six months’ salary, ideally, to cover shock expenses such as a boiler breakdown or car repairs.
Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, says everyone should have money set aside for rainy days.
“Set up a monthly withdrawal from an easy-to-access savings account.”
10 Seek help if you are still struggling
If you have serious problems, get help from an outside debt specialist, while avoiding private debt management plans that charge a fee for their services.
Try the government-backed guidance service moneyhelper.org, or get free help from StepChange Debt Charity or Citizens Advice.