Attack your debt and give no quarter

UK consumers owe £1 trillion and rates are rising, says Melanie Bien. So bring down your borrowing before it brings you down
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The Independent Online

The Bank of England's decision to raise interest rates by a quarter of a point to 4.75 per cent last Thursday wasn't surprising. But whether they expected it or not, those who have taken on a lot of debt in the past few years could find that it proves the final straw.

With UK consumers in debt to the tune of £1 trillion, plenty of us have taken on more credit than may be wise. While this may not have been a problem when rates were at a 40-year low of 3.5 per cent, as was the case last October, there have been four quarter-point rises so far this year and rates are widely predicted to go up again next month. So for many of us, it's important that we consolidate our debts now. If you have savings, you should consider using these to reduce what you owe.

"Ask yourself, 'what rate am I paying on my debt and what rate am I earning on my savings?'" says Darius McDermott, managing director of independent financial adviser Chelsea Financial Services. "It may be prudent to pay off your debt if you have some savings, but it depends what you are saving up for. If you [almost have enough] for the new car you were after, you may not want to use this money to clear debts.

"But if your savings are just sitting in an account and not earning a lot of interest, you could decide to use them to reduce your debt."

Although the rate of interest on savings accounts has been increasing as well as that on mortgages and personal loans, you may still find it makes sense to use your stash to clear your borrowings. For example, you could be enjoying one of the highest rates of interest available on savings: 5.1 per cent tax-free in an Abbey postal mini cash individual savings account (ISA). However, if you are also paying 29.9 per cent interest on an outstanding balance on a Laura Ashley store card, you will not be making the best use of your money.

And remember, if you have a "regular" savings account, the returns will be even smaller because you will be taxed on the interest you earn.

Given that your mortgage is likely to be your biggest debt, you should tackle this first because this is where you could also find yourself making the greatest savings.

If you are on a variable-rate deal, consider remortgaging. Find out from your lender or broker whether you will have to pay a penalty for doing so. This may be the case if you took out a fixed or discounted deal that has now ended but has extended redemption penalties.

In some cases, the cost savings may make it worth your while paying the penalty to switch to a more competitive mortgage rate.

If you are coming to the end of a fixed or discounted deal, you should also think about remortgaging. But Ray Boulger at broker Charcol warns not to fix for longer than two years because there is a "general expectation that the base rate will have peaked ... and be on the way back down by then".

Two-year fixed-rate deals have fallen below 5 per cent once again, with Britannia building society, Charcol and the Halifax all offering 4.99 per cent.

If you have savings, it is worth making overpayments on your mortgage. This will ease the burden if the base rate rises further and help you clear the loan early, saving thousands of pounds in interest.

Most lenders will allow you to pay a lump sum of up to 10 per cent of your mortgage each year without penalty. But remember to use only cash that you won't need at a later date because you won't be able to claw it back - unless you have a flexible mortgage. Alternatively, opt for an offset deal that lets you keep your savings separate while still using them to reduce the interest on your loan.

Once you've tackled your biggest debt, you should get rid of any store cards, as rates tend to be astronomical. Even if you don't have spare money that can be used to clear the balance, you can still save money by moving the debt to a credit card charging 0 per cent on balance transfers. Barclaycard, Virgin Money, Bank of Scotland, Halifax, Egg and Tesco offer 0 per cent introductory periods, ranging from five to 12 months.

While you're about it, check you aren't paying over the odds on the rest of your plastic if you don't clear your balance each month. Shift outstanding debt on to a 0 per cent credit card and use the interest-free period to chip away at it.

Next, look at personal loans. These are less easy to clear early because many providers charge a penalty for doing so. And by switching to a loan, you will have the discipline of set payments each month.

But if you owe a lot on credit and store cards, you may want to consider taking out a personal loan to clear this debt as rates tend to be lower. Northern Rock is charging 5.8 per cent, for example.

Steer clear of loans that promise to consolidate your debts into one single payment, though, even if you are struggling to pay creditors. These deals may sound convenient but the rate charged is usually much less competitive than that on a regular high-street loan.

Consolidation loans also tend to be secured on your home, so you could lose the property if you default on your repayments. You would be far better off shopping around for a cheap personal loan.

Check out websites such as www.moneysupermarket.com or www.moneyfacts.co.uk for the cheapest deals.

TIPS FOR DEALING WITH DEBT

* Don't panic but don't ignore the problem because it won't go away. And don't take on any further debt.

* Calculate your total income.

* Work out your most important debts - the ones where the creditor has a drastic sanction like repossession (mortgage arrears) or cutting off your gas.

* Work out your total outgoings (include the cost of important debts). See if there are areas where you can save.

* Subtract your outgoings from your income. If you have money left over, this can be split between your remaining creditors. If you haven't got a surplus, or enough of one, contact your local Citizens Advice Bureau for help (www.adviceguide.org.uk).

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