Debts, two kids and a nest with no nest egg: it's time to lay financial foundations

Wealth Check: Each week we give 'Independent on Sunday' readers a financial makeover
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The problem

The problem

Sophie Marsden is the first to concede that her personal finances need a wake-up call.

Her circumstances have changed radically after a divorce and, reviewing her financial predicament, she realises she has an awful lot to do to lay foundations for the future.

"I have full responsibility for sorting out the mortgage and trying to provide for my future and that of my children," she says. "I definitely need to be a bit more savvy about money generally, and savings in particular.

"I would like to start straight away with an individual savings account [ISA], perhaps putting £1,000 into one."

This is the right attitude, given that she has yet to put anything away. Nor does she have any investments, although, after a recommendation from a friend, she is interested in premium bonds. Alternatively, she would be happy if any money put into the stock market could be invested in ethical funds.

Apart from on her home, her only debt is a £3,000 personal loan with NatWest at 11.5 per cent. She is halfway through its three-year repayment period.

Her east London house is worth an estimated £220,000 but the mortgage deal is for significantly less. In total, the loans add up to £131,000 and comprise two Abbey National repayment mortgages.

The first is for £85,000 - a five-year fix at 6.25 per cent. This tie-in comes to an end on 2 August this year when a new, cheaper deal can be struck.

Any move to switch ahead of the summer would incur a £2,000 remortgage penalty.

Her second mortgage slice is for £46,000, on a more competi- tive five-year fix at 5.19 per cent. This deal ends in summer 2007.

As for retirement funds, she benefits from a non-contributory final salary pension that pays in the equivalent of 5 per cent of her salary. She has worked for the Public and Commercial Services trade union for four years but has yet to make any of her own contributions.

She also has a £100,000 life insurance policy, taken out with NatWest a few weeks ago at a cost of £7.50 a month, but is aware this might not be enough, given that she has children and mortgage repayments to cover.

There is no income protection or critical illness insurance in place but she is fairly confident that her employer will provide a decent level of cover if she should fall sick.

Her main concern, however, is her house. "I'm not sure whether to keep it or sell it and put the money elsewhere," she says. "My brother is going to buy a house in south London and I could live with him for a while."

The patient

Sophie Marsden, 31, from Leytonstone, east London.

Job: part-time administrator for the Public and Commercial Services Union (PCSU).

Income: works three days a week, receiving a £25,000 pro-rata salary.

Savings/investments: none.

Debt: a £3,000 personal loan with NatWest at 11.5 per cent over three years.

Goal: a desperate need to start saving for her own future and that of her two young children.

The cure

For holders of premium bonds, the chances of winning a big prize work out at 30,000-1 for each £1 invested, says Justin Modray, senior investment manager at independent financial adviser (IFA) Bestinvest.

"While the lure of the £1m tax-free jackpot might be tempting, the average return on premium bonds is 2.4 per cent - a safe way to have a flutter but not the core of a long-term savings plan."

In the meantime, if Sophie is not penalised for doing so, overpaying on her personal loan to reduce her debt is a good way to kickstart her finances, adds Mr Modray.

Savings

Sophie should start saving into a deposit account, advises Vivienne Starkey, managing director of IFA Equal Partners. She recommends ING Direct's savings account, paying 4.41 per cent interest.

A mini cash ISA is also advisable. Mr Modray proposes Abbey's 4.6 per cent deal, although there is a penalty for withdrawing any cash before two years are up. Safeway offers a competitive 4.35 per cent, he adds.

Investment

Ben Yearsley, investment manager at IFA Hargreaves Lansdown, recommends an equity ISA, but only after Sophie has got into the savings habit.

"At the moment, Sophie should concentrate on saving cash. However, in the longer term, Cazenove's UK growth and income fund is a good first-time choice for equity investment," he says.

Ms Starkey says that, with an ethical outlook, Sophie should opt instead for the Isis Stewardship Income fund, which requires a minimum £50 monthly investment.

Mr Modray proposes that Sophie begins investing with an ISA tracking the FTSE 100 index. "M&G's tracker fund has a 0.3 per cent annual charge and she can save from £10 a month."

Retirement

Both Mr Modray and Ms Starkey think Sophie should stick with her current pension scheme for as long as possible.

Ms Starkey adds that when Sophie can afford to make her own contributions into the pension fund, she should consider asking if she can put in extra money and "buy" additional years. Although this may be an expensive short-term option, she will benefit when she comes to collect her retirement payout.

Protection

Mr Yearsley says Sophie needs more insurance to safeguard her children's future and to cover the property in the event of her death.

"Life cover of £250,000 for 25 years costs £12.50 a month from Norwich Union. This would pay the mortgage off and leave some money for the children."

Once this has been arranged, she could consider income protection, adds Mr Yearsley, although that might not be cheap. Bupa charges £23.57 a month for a £10,000 annual payout; the scheme does not kick in until the individual insured has been off work for three months.

Mr Modray advises Sophie to check the terms of her final salary pension scheme for death benefits. Coupled with the NatWest life insurance she already has, this may offer enough protection to save her taking out expensive additional cover.

Mortgage/property

Sophie might be better off staying put, says Ms Starkey. If she were to sell her house and move in with her brother, she could find it difficult to get back on the property ladder.

Since interest rates are expected to rise over the next 12 months, she should take the best fixed-rate deal available when the mortgage tie-in ends in August, Ms Starkey adds.

Mr Modray agrees Sophie should not sell her house, and suggests she consider renting out a room instead.

He explains: "Under the Inland Revenue 'rent a room' scheme, provided the room is rented as furnished, she can earn up to £4,250 a year in rent without having to pay tax."

Interview by Sam Dunn

If you would like a financial makeover, write to Melanie Bien at The Independent on Sunday, Independent House, 191 Marsh Wall, London E14 9RS, or m.bien@independent.co.uk

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