As adults, we are conditioned to accept being in debt. From an early age, we are encouraged to enter into debt to improve our lives. The legal age that you can own property in the UK is 18 years old. That is also the age where you can go to the pub, vote and of course, borrow money.
Sometimes borrowing money can be a good idea. Getting a mortgage to purchase a home for example. However, most of the time, debt is bad.
Many people become students at age 18 and sign up to large student loans to finance their education. While getting an education is a great idea, the cost is very high these days, and for most, that means getting a big loan which will be repaid once they have a job.
In addition, banks are very keen to offer students large overdrafts to help them get through university. I’m sure that many students want to have the best time they can and may also get a credit card to borrow on too.
By the end of the 3-4 years at university or an apprenticeship, most people will find a job which pays reasonably well and has good career prospects. After such a long time of being skint, people want to reward themselves for all the hard work and success, so they buy a car, eat out in nice restaurants they could not afford as a student, and generally party with friends.
That’s OK because your friendly bank just offered you an extended overdraft to help you through that difficult phase of partying. They also raised your credit limit because you are a good person. Go on, buy those clothes. You deserve them.
Before you know it, you are up to your eyeballs in debt. But that’s OK because this is normal and everyone else is too. You have been rewarded with a great credit rating so you can borrow more money.
You’ll need it because now all your friends are getting married and going on Stag and `Hen do’s around Europe. Thank God you can put it on the credit card and pay it later. It’s OK too because you are earning Avios, so it’s like you are saving money.
Before you know it, you can’t breathe because you are living pay-day to pay-day and spending on a credit card just to get by. You are drowning in debt.
Think. Does this sound familiar?
You are in an emergency. The roof is on fire. The shit has hit the proverbial fan. You MUST act or your will certainly be financially crippled and working until you die a miserable consumerist death.
Now let me help you.
Step One – Wake up!
Step one is realising the situation and potential hole you have dug for yourself. You need to take stock and understand that this is unsustainable. You can’t go on like this. I suspect if you are even reading this you have already worked this out. Well done. Now you need to find out the size of the problem you have. You don’t want to be working until you are 75 to pay for all these things, do you?
Make a spreadsheet which lists out the following:
I’ve made an example for someone who may be in their late 20s or early 30s above.
It can be quite an effort to get hold of all this information and sometimes you may have lost track. That’s OK. Losing track is a coping mechanism of sorts. Burying your head in the sand is the natural reaction to this situation. Step 1 is about lifting your head above the earth and looking around.
Look through your direct debits in your current account and see if there are payments going out. It should say to whom. Try looking for statements online. Get onto the online account of the provider and find out the balance. This can take a while and be a pain but please see it through. Do it on a Sunday afternoon when it’s raining (but don’t wait until a rainy Sunday to do it!).
I would recommend getting an account at Checkmyfile.com. Checkmyfile offers a 30-day free trial, which is £14.99 a month thereafter and can be cancelled at any time. You can check all the credit reference agencies in one place at the same time and see if you have any credit cards you have forgotten about or stray loans you may have forgotten. I personally subscribed for a few months and sorted out a lot of issues with my credit file. Sorting out my credit score improves my chances of being approved for a loan if I need it (good debt only), and lowers the interest rate I will pay on my “good” debt such as my mortgage.
Run a check against your own records and payments with those in Checkmyfile.com and make the table above. *
Step Two – Categorise
Congratulations, you now know where you stand and the size of the task ahead. The next task is to categorise the debts.
Not all debts are bad. For example, if you have a mortgage, this falls into the good debt category. The student loan debt is also sort of good. It will be paid regardless by your company from your salary. Let’s not worry about that one for now.
Credit card, store cards, and hire purchase agreements fall into the ‘bad’ debt category. These are the debts that are really holding you back and costing you the most money.
Assign a category of good and bad, then look at the bad ones.
Step Three – Prioritise
Once you have categorised, you should then look seek to prioritise the loans you want to pay off. Start by looking at the interest rates you are paying on each debt. The highest interest loans should be tackled first. In the example above, the AMEX is the highest at 23%.
We’ve already said not to worry about the mortgage for now, so the student loan is the next lowest priority. Park it for now and look at the other loans first.
Step Four – Paying Down the Loans.
This is by far the hardest part. It will take time. It will require discipline. It will make you feel sad.
Personally, I am a fan of consolidating loans into one with a lower interest rate and a single payment. If you think you can do it, transfer the credit cards to a new introductory card with 0% interest and make the highest payment you can make on to it. You must be disciplined as one missed payment will cancel the 0% offer in most cases. Cut up the card you paid off.
Alternatively, you can do the snowball method. Pay the most you can on the highest interest loan whilst paying the minimum payment on other loans. Once that loan/card is paid, you pay the same amount you were paying to the previous loan into the next highest interest loan and repeat. Eventually, you will be paying off all the debt quicker each time.
Check out how much you can sell your car for on Motorway.co.uk. If it’s above the value of the remaining loan, sell it. If not, then try to pay it down until the value is higher than the debt and sell it.
If you can’t bear to sell your car (I know I struggled with this one) you can also pay it all off quicker by continuing the snowball method on the finance deal. Once it’s paid off it’s your car.
You will be surprised how satisfying it is to pay these off.
This is the hardest bit because it involves saying no to many things that you like doing so you can save the money to pay off the loans. I’m not going to sugar coat it. Stop eating out and cook at home. Don’t go to the pub for a few weeks. Consider postponing that holiday or turning down an expensive wedding invitation.
Step Five – Invest
Once you have paid off your loans, save up an emergency fund. This serves two purposes; one, to give you money to use in an emergency, and two, money to lend to yourself. By lend to yourself, you pay for an item (an essential purchase only!) from the emergency fund and then pay back the money over a few months. You should aim for 3-6 months of monthly expenses. Keep the saving spirit you learned while paying down the debt.
You can also consider making additional payments to your student loan. If you are on Plan 2 I think you should do this as the interest is quite high if earning above £46k. If you are on Plan 1 – maybe don’t bother and pay the minimum. The returns from a Vanguard ISA will outweigh the interest on this loan. Money-saving expert has a great article on this.
The End (of your debts)
So, there we have it. Debt is bad (mostly). But follow my plan above and you will be free within a reasonable time. It took me 6-7 months to do it. I thought it would take me about 2 years when I started but things started to accelerate. It’s not easy, but I know you can do it.
* This is an affiliate link to Checkmyfile.com. Being totally open, if you sign up I may get a small fee for you doing so. It’s to cover the modest cost of running this blog. I am recommending them because I think their service is great and use them myself. I actually found out I had a bunch of issues with my credit file and they helped sort them out by contacting the credit agency and putting things right.