Debt management 101
By Rachel Williams
Debt is no longer a dirty word. Fifty years ago, if you didn't have the money for something, you didn't buy it; today we have a national debt that stands in excess of £1.1 trillion as we use credit to pay not just for our homes, but our lifestyles.
Of course there's nothing wrong with borrowing money. The availability of cheap credit is helping us manage our finances more effectively.
However, the changing face of borrowing comes at a price as we all become increasingly vulnerable to serious debt problems. Recent research from the Consumer Credit Counselling Service reveals that the number of people earning more than £30,000 a year who request help from the charity has risen by 257% in three years.
Saran Allot-Davey of IFA Heron House Financial Management explains that you don't have to be wealthy to stay out of debt, you just need to know how to manage your money.
A key part of keeping your finances under control means learning to see where the debt traps lie and managing your finances.
Debt trap 1 - University
With the grant system resigned to history, coupled with tuition fees, debt is par for the course. Unless you're from a wealthy background it's highly likely you'll leave with an overdraft and a handful of student loans in addition to your degree. According to Barclays, in 2005 the average student finished their studies with debts of £13,500.
To keep borrowing to a minimum, budgeting is essential. Before even thinking about borrowing, students should consider working part-time. Money or no money, Jo Roberts, an IFA at Needanadviser.com says paid work should be an essential feature of university life.
If you have to borrow, think first. Students should start with interest-free overdrafts. The next option is student loans. Only if you're desperate should you consider credit cards.
Debt trap 2 - First job
While entering the world of work is all about gaining financial independence - the reality is that your finances are likely to be stretched. James Falla, director of debt consultancy Thomas Charles says: 'People's expectations of the cost of living are way off - they forget that when they start work their lifestyles will change.'
First-jobbers should shop around for the most competitive credit cards if they need to borrow. If you already have student debts, budget and repay as quickly as possible. If this isn't feasible, a personal or graduate loan can help get you back on your feet.
Use this summer to give your finances a thorough health check
Debt trap 3 - Buying property
The cost of housing today means a mortgage is a bigger commitment than ever. According to Halifax the average first-time buyer is now 34 and takes five years to save the deposit. But whether you're on the first, second or third rung of the property ladder, buying a home can stretch your finances to the limit.
However, it's not just the size of our mortgages that can land us in hot water, as moving costs don't stop when you move in. 'People then go and take extra credit out to furnish the house,' says James Falla.
Just because a lender is willing to lend you money, it doesn't mean you can afford it, so it's essential to go through a budget to work out how big a mortgage you can afford.
As soon as you take out a mortgage, you need to have a strategy in place to ensure that if your circumstances change, you can still meet your repayments. So, experts recommend you always have between three and six months' salary in savings. While savings can form a short-term buffer, the right insurance can provide much more watertight protection.
Debt trap 4 - Getting married
According to Alliance & Leicester, 15% of couples plan to borrow to fund their wedding, but given they're likely to underestimate the cost by around 155%, many more will resort to credit. While the big day might be perfect, debts can mean you start married life on the wrong foot.
Debt trap 5 - Having kids
Borrowing in order to prepare for a new baby should sound the warning bells. If you can't afford these expenses now, how are you going to cope when the mother is on maternity leave?
As soon as you get married and have kids it becomes even more important that you have insurance-based protection, not just those policies that pay out if you become ill but life insurance too.
Whether buying a house or starting a family, you need to lick your finances into shape
However, Saran Allot-Davey warns: 'I come across lots of people who are spending so much money on policies that aren't right for them. You need to think about size of benefits, when the plan will pay out and how easy it will be to claim.'
Debt trap 6 - Getting divorced
However amicable your divorce, if children are involved, money is going to be tight as your joint income needs to support two households. It's distinctly unromantic to plan your finances around the prospect of divorce. However, one thing you should do is to ensure that if you're borrowing together, the application is made in both names. According to Debt Free Direct, 70% of those with serious debt problems conceal them from their partner. If you do split it's worth being aware of the financial implications of any knee-jerk spending or credit application.
Debt-trap 7 - Retirement
The more you borrow during your working life, the greater the chances you'll still have debts when you retire. According to Scottish Widows, one in six pensioners today is still paying their mortgage. We're also much more likely now to keep borrowing once we retire. The problems occur because most of us suffer a big drop in income when we stop working. At the moment, debt isn't a huge problem for the elderly, but if we keep on borrowing as we are, it soon will be.
Anna Bowes of AWD Chase de Vere says it's essential you enter your retirement prepared and get a clear idea of your financial footing. 'Planning for your retirement is about more than just sorting your pension,' she says.
Many pensioners will have no choice but to work part-time. While this might not be the retirement you dreamt of, the reality is you may well enjoy it.
Equity release can be an attractive option for homeowners, allowing you to access some of the equity in your home, without moving out. Equity release can undoubtedly be a life-saver for many people; however it should only ever be your last resort. Although you'll never end up owing more than the value of the property, it can be expensive - potentially wiping out all the equity in your home.
Your debts are spiralling out of control if…
• You need to borrow in order to repay existing debts
• Repayments on your unsecured debts exceed 20% of your take-home pay
• You need to use your credit card for essentials like food, petrol and bills
• You can't afford to pay the minimum balance on your credit cards
• You're receiving letters chasing for payments
• Your finances are worrying you and affecting your relationships
Editor's note: With thanks to Interactive Investors, where this piece first appeared. Please note that this article is aimed at UK residents. Always seek expert opinions before making important financial decisions
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