Dealing with Debt

For many of us, some form of debt is a fact of life, but in my view it’s something we should use for our advantage rather than against us.

Carrying a lot of consumer debt such as credit cards and loans acts like an anchor dragging behind us or trying to drive with the handbrake on.

Not that I am demonising all kinds of debt, far from it. How difficult would buying a house be without a mortgage or many of the functions of modern life without some kind of credit option?

My purpose here is to encourage you to pause for a moment and think about how much debt you have and how quickly you can pay it off.

Photo by Anete Lusina from Pexels

How to Save Money on Credit Cards

If you have credit cards do you pay off the full balance very month? If so great, if not you are certainly not alone. The average credit card debt in the UK is almost £2000.

Do you remember opening a credit card account? Whether online or over the phone, you were most likely given the option to make you monthly payments by direct debit. Which is a good thing, so you don’t forget the payment and incur fees plus damage to your credit score.

But here’s the thing, the credit card companies usually give you the option to pay the full balance or a minimum percentage such as 2 or 3%. This is a sneaky trick which costs you more in interest and takes years to pay off the debt. Think about it for a moment, how do the credit card companies make money? Largely by charging you and I interest on our outstanding balances right. So, it’s in their interest (excuse the pun) to keep you paying the debt for as long as possible.

I made a video which explains saving money on credit cards in more detail:

As an example, if you had £2000 outstanding on your credit card at a 20% APR, a minimum 2% payment would be equivalent to £40 a month.

If your direct debit was set up for this £40 fixed payment it would take 7 years 11 months to clear the debt and a total interest cost of £1,818.

But if you just left it alone and paid the 2% as a direct debit it would take, wait for it, 42 years to clear the debt at a total cost of £5,588!

I don’t know about you but that makes me angry and is one of the reasons I am so passionate about financial education to stop people being ripped off like this.

Find a Lower APR

Once you have ensured you are paying a fixed amount, rather than a percentage the next step is looking at the cost of interest or APR and if you can switch to a cheaper provider.

In these days of low interest rates, there is no need to be paying 20 or 30% interest on your credit cards. Use a comparison site to see if you can switch outstanding balances to a lower rate card or take advantage of a zero percent offer.

Of the money you pay every month, the vast majority goes towards the interest and very little is taken of what is called the principal, or amount you owe. So basically, you are running to stand still.

With a zero rate card, the payments are all going towards paying off the principal, which is why the debt can be cleared faster.

What about debt consolidation loans? Good question. If you have several credit cards at say 20% interest and could clear them with a loan at for example 10% that would make sense, right? Well, maybe, it depends on how long you take the loan out for. Its tempting to go for a longer term perhaps 5 years or more and thereby reduce your monthly outgoings. But remember to look at the total cost of borrowing, which should be provided.

It’s nice to reduce the amount you are paying every month, particularly if money is a bit tight at the moment. But it can be a false economy if you end up paying more in interest in the long term.

Plus if you do go down this route, once you clear your credit cards don’t be tempted to start spending on them again. Hide them in a drawer for emergencies or close one or two if you have several. Keeping your credit utilisation rate low improves your credit score. So as tempting as it might be to ceremoniously cut them up, keeping a credit card with no or low balance can be a good thing.

Having a Plan

The third way I am going to suggest you deal with debt is by creating a plan for overpaying your credit cards and loans but in a systematic way.

In my courses and live events, I teach a system called the snowball effect.

To start write down the outstanding balances on all your credit cards and loans. You may wish to use a simple spreadsheet or a pen and paper.

Then write down the interest rate and minimum monthly payment for each one.

Next rank them in order of the outstanding balance, with the lowest at the top.

Each month you commit to overpaying that amount by as much as you can. Maybe you can earn a little extra from working overtime, a second job or a side hustle business. Maybe you can also trim your expenses elsewhere.

Imagine that the minimum payment was £40 as in our earlier example and you could find an extra £50 per month and you directed the combined £90 at the first balance. All the extra payments are taken off the principal because your regular payment is covering the interest.

After a few months that debt has gone. You now have a ‘spare’ £90 per month which you use to target the next lowest balance. Now that card will be cleared in a much shorter time and you can roll the mount you were paying there onto your next debt.

It also works for loans and even your mortgage, if your provider will allow a degree of over payment.

In Summary

Lots of information here so let’s recap.

Start by getting clear about how much you owe, and the minimum payments needed for each card or loan.

Then look to switch to zero or low-rate cards if you can.

Ake sure you are paying a minimum amount as a fixed sum rather than a percentage.

Finally use the snowball effect to create a plan and stick with it. You will see the debts dissolve in record time.

It takes a little time and discipline but as Jim Rohn so eloquently said, the pain of discipline is always less than the pain of regret.

If you would like some help or coaching through this, debt management forms part of my Financial Liberation programme, which is a 6-week live online course. Details are on our website at fearlessfinance.co.

Credit Card Debt – Are You Paying Thousands in Extra Interest?

Millions of people around the world use credit cards and despite our best intentions of clearing the balance very month, most of us will carry a balance. In fact the average outstanding credit card balance is $5700 in the USA (source ValuePenguin) and is over £2500 in the UK.

Chances are when you take out a new credit card you will be offered the opportunity to pay via direct debit either the full balance or the minimum amount every month. Since most people use credit cards as flexible spending for emergencies or contingencies it can be difficult to commit to paying off the full amount. This is especially true when transferring a balance from another card.

Paying too much interest n your credit cards- credit card image

Statistics show that over 65% over credit card holders carry a balance from month to month

Did you know that if you opt to pay the minimum balance you could take over 20 years to pay off the card? It is far better to agree a fixed monetary amount each month than the percentage which is often suggested by the credit card company.

The video below explains in more detail and you can prove it for yourself by using a credit card calculator

For more financial education tips and videos visit The Personal Finance Academy


What does APR mean – and why should you care?

There’s a saying that guns don’t kill but people do. Implying that the gun is just the tool, the inanimate object but the person holding it is responsible for their thoughts and actions.

Many credit providers appear to take the same view. It’s not the availability of easy credit that causes debt problems but people with many needs and wants looking for instant gratification. One of the issues I have with that argument is that while there is a general lack of financial education then consumers do not know the full implications of buying on credit or taking out simple, quick payday loans.

One of the main elements is a lack of understanding about the true cost of the borrowing, the bullets in the gun, the APR. The Annual Percentage Rate (APR) is used to provide a guide to repayment costs and provide a benchmark for comparison with other lenders.

In simple terms a loan of £100, or $100 taken out over a year at an APR of 10% would cost £110 ($110) or an additional 10%.

When loans or credit agreements are taken across several years it gets a bit more complicated but the principle is the same.

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What is APR – video

Factors Affecting APR

Several factors affect the APR at which a person can borrow, these can include:

An individual’s credit rating – the ‘safer’ you are in the credit provider’s eyes the lower APR you can obtain. If you are employed with no record of missing payments and perhaps a homeowner with other credit cards etc. then you will typically be offered better terms than someone without these.

For February 2011 in the UK lenders who advertised their APR rates must show representative rates. They may have a range of terms (prices) but must show figures as a representative example. This prevents people from seeing a rate advertised and assuming that this is a fixed price for every customer.

Secured or Unsecured – if you are borrowing as an individual or for business, if you can offer security or sometimes called collateral then you may receive favourable terms. The lowest APR rates are usually for mortgages which are secured against the value of the property.

Length of term – Banks and other financial companies are in the business of making profits. One of their main methods of doing this is by lending money and charging interest. If you wanted to borrow over 3 years to buy a car for example, they may charge a lower APR than a shorter term loan or overdraft. This means that they will be receiving interest over 3 years albeit at a lower rate.

Why is some APR so high?

Some finance companies and so called payday lenders offer short term loans at very high interest rates, ranging between 800 – 3600%. Their acceptance criteria is generally lower than high street banks for example and so their business model anticipates that a percentage of borrowers will default, or not be able to payback the loan. Customers who do pay their loans back are paying extra to offset those who don’t.

As the name suggests, payday loans are designed to be short term, typically less than 90 days. Therefore the full extent of the high APR figures is not generally considered. Borrowers are typically in urgent need and are looking at a solution to their problems rather than part of a sound financial plan.

Also payday loans will generally be smaller than other borrowing, perhaps limited to £500 or £1000. In this way the customer does not again see the full implications that a high APR brings.

Why should you care about APR?

In many cases it is almost inevitable that people will need to borrow money at some point in their lives. Whether student loans, buying a house, or financing a business. Other borrowing can in my view be more discretionary but society, advertising and other pressures may say different.

When looking at borrowing take a look at the APR and consider whether this is the only or most appropriate form of finance. Will the ‘loan’ be short term or long term and what level of repayment can you comfortably afford. Will this also be true should your circumstances change? Finally look at the overall cost of the borrowing added to the purchase price. A bargain purchase may not seem such a bargain once the full cost of borrowing has been added.