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Saturday, 29 January 2011

How to Survive Debt

All debt is relative.

A debt of ten pounds for someone who earns nothing is a bad debt. Just as a debt of twenty thousand is for someone on a thousand a month. So, the size of the debt is not the issue here. After all, a million pound mortgage on a house worth two million could be absolutely fine for some.

Debt is built up in two ways. There is the initial spend which causes a person to go into debt in the first place. Then there is the compound accumulation of interest and fees which are associated with this debt which help it to build up and up and up.

I am not sure how many of us are equipped to understand the complex calculations done by the banks when they work out just how much money we owe them. In very simple terms, in case someone does not know, debt can be compounded as follows.

If you owe someone £100 at 5% interest a month, then at the end of the first month, you owe them £105.
At the end of the second month, if you haven't paid anything back, you owe them  £110.25, which is 5% of £105 added on, and so on. So, at the end of ten months, if you have not repaid anything, you owe them a grand total of £162.89p.

This is a wonderful device for all the banks to get us to pay back much more than we borrow. But it is that important percentage that is so important. If we paid back 6% interest instead of 5%, then we would owe £179.08p, over £16 more!

These are the basics to be aware of when initially borrowing the money. Compounding that debt is not going to do you any favours. The shorter the term and the lower the rate, the better. So it is a wise decision to never pick up the phone and call one of the new companies which offer short term debt at 1000% interest.

They are there, the adverts are cropping up. All they need is a million punters overpaying a few hundred pounds a month.

And it goes without saying to never, ever go to a loan shark. Or else, just chopping off an arm or a leg and handing it over to them first would be much better.

So, being in debt is actually fine, good debt is the way that smooths the wheels of industry - or something. But then the letters start coming through the door. Debt attracts more debt it seems.

Your lender will slowly inch up your credit limit if you are a good customer. They will offer a good short term rate to get you started, and then when you have built up enough of a loan with them, they will hit you with the full interest rate.

Other lenders will jump on the band wagon. More letters will arrive offering you more credit cards, store cards, loans for a car, holiday, doing up your house.

There are two facts to note here:

Buying things using a card is way easier than using actual money.  Firstly, it never seems to feel like real money. You just hand over the card and enter the pin number and it is all very clinical and painless. There is no counting out the small change and handing over the notes. It no longer matters whether you have the right change with you at all, you can pay for any amount of purchase - just use your card!

The second thing to note is that a lot of little amounts can build up to an extremely large total. Imagine five purchases of just under twenty pounds. It will not feel like you have just spent a hundred pounds, but that is what it means. Over a week of small purchases, it can add up to many hundreds of pounds.

So How do you Survive Debt?

The aim of someone who is in debt must be to get out of debt as quickly as possible. As painful as it will be, first of all, find out, or work out exactly how much debt you are in. Although you have kept a running total of your spending in your head, the actual figure may be very surprising. It could be thousands of pounds out when interest fees (compounded), late payment fees, overdraft facility fees, paper bill charges (yes, they do charge to send you paper statements) and manager's lunch  (car, second house in Spain) fees are added onto the top.

Work out how much you owe.

Next, sit down and work out income versus expenditure. This is quite easy these days, with online banking and downloadable statements. You can easily what is going out, where and how and what it coming in.

As Charles Dickens said: "Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery."

Cut down where you can.

Plan to overpay as much as you can within the terms of your borrowing. Some lenders protect the repayments they expect to receive by putting a limit on how much you can pay back.

See if you can earn more money. Can you let out a spare room? sell anything online? Offer tuition for a skill you have? Piano? Good head for numbers?

If you are in difficulties let your lenders know as quickly as possible. They are mean, they are callous, but they will try to protect their investment. If you can convince them to agree better terms, and still pay, then they might agree.

Aim to pay off your most expensive debt first. Take it slowly, one step at a time. Don't hide, act now! 

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