The financial lifelines to grab if a door slams shut in your face
From free advice to cheaper credit, help is always at hand, reports Rob Griffin.
Friday 07 June 2013
Many of us will hit financial problems at some stage in our lives. These can be triggered by life-changing events such as a costly divorce, losing a job or suffering a debilitating illness – as well as simply not being able to make ends meet.
So what do you do when your finances implode and you tumble into debt? How do you handle your creditors and where can you go for short-term and cost-effective sources of revenue as an alternative to paying huge interest to payday lenders?
The first thing to realise is that you're not alone and there are people who can help, according to Justin Modray of the advice site Candidmoney.com, who insists the worst responses are either to panic or, at the other extreme, to ignore such problems in the hope they will magically disappear. It is also important to choose carefully if you are considering taking on a new debt to repay another debt. "Don't borrow blindly as you could end up paying a fortune in interest that will compound your woes," he says. "You must also avoid the easiest option of an expensive loan company, as they will be happy to throw money at you but are likely to charge you an arm and a leg."
Put together a detailed household budget
Each year, more than 400,000 people seek help from StepChange, the debt charity. According to Jonathan Ches-terman, one of its debt advice managers, the first step is to get a grip on your finances. "The key is putting together a budget based on your current financial income, making sure you have allowed for essentials such as rent/ mortgage, council tax, utility bills, food and the cost of travelling to work. These must be the top priorities."
Then see where costs can be cut - how can you reduce your outgoings? Among the most common ways in which money leaks from accounts is through under-utilised club memberships or TV channel subscriptions, according to a survey by Gocompare.com.
If your situation has changed dramatically, you may qualify for benefits, so contact Citizens Advice to ensure you are getting everything to which you are entitled. Log on to www.citizensadvice.org.uk to find your local bureau.
Examine existing investments and policies
If you are in the fortunate position of having savings then you may have to consider liquidating your assets, especially as taking on debt is likely to cost you substantially more than what you receive in the form of interest.
Patrick Connolly, a certified financial planner at Chase de Vere, says you must fully understand what savings and investments you have in place and consider restructuring them. "If you need to access money, you should start where there are no exit penalties, no tax issues and where the money isn't currently in a tax-efficient wrapper such as an ISA," he says. "Aim to keep your money as flexible and low- risk as possible, which might mean taking it from investments and putting it into short-term or instant access cash accounts, so you know it will be there when you need it."
If you are paying monthly premiums into investments then in most cases it will be sensible to stop these, at least temporarily. You should also review any protection policies, such as life cover, critical illness or income protection, to see if cheaper deals are available elsewhere. "If you still need cover, only stop these policies as a last resort because you may be leaving you and your family vulnerable," adds Mr Connolly.
Manage your debts
Once you have a detailed budget for your monthly income and essential living costs, it's time to get a grip on any outstanding debts. "If you are struggling to pay certain bills, make sure you keep in touch with creditors so they are aware of the situation," adds Mr Chesterman at StepChange.
If the budget exercise illustrates that you simply haven't got enough money to fund all your essential costs and repayments to creditors, seek help. There are plenty of free services, so don't ask for advice from those charging a fee.
Consider sources of funding
Even if you have been efficient in your forward planning, there may still be times when you need to raise money in the short term. There is no shortage of options but you will need to consider the various pros and cons of each before making your decision.
Remember that you will end up paying back considerably more than you are originally lent, points out Geoff Penrice, a charted financial planner at Astute Financial Management, who cites the example of borrowing £5,000 at an interest rate of 17.2 per cent.
"If you can pay £100 per month, it would take 89 months to clear the debt at a total cost £8,900," he says. "A payment of £75 per month would take 219 months at a total cost of £16,425, while paying £150 per month would reduce the payment time to 46 months at a total cost of £6,900."
Your best bet is to borrow from family members as you probably won't have any interest to pay and will be able to agree a repayment term that suits – but think twice about tapping up friends. "Friendships and money don't mix and I hear of many friendships being ruined in this way," adds Mr Penrice.
If family help isn't available then consider credit unions, which are member-owned financial co-operatives that offer affordable methods of credit. There are more than 400 such organisations across the UK and you can find a local one at www.creditunions.co.uk.
Your next option is using your overdraft facility, if one has been offered by your bank. This can be a viable option if your problem is very short-term, although the concern is that if you go over the agreed overdraft limit then you can face steep penalties and interest charges.
Another alternative is credit cards. These can be a fantastic source of short-term funding – especially those offering interest-free periods on purchases, balance transfers or both – but they need to be managed very carefully or the financial hit will be huge.
The next option is taking out a loan. Although Mr Chesterman advises thinking twice before taking on any more debt, he says that if a loan is the only way out of a problem then you should opt for a high-street bank and shop around for the best-possible interest rate. "The advantage of loans over credit cards is that you know exactly how much interest you will be paying right upfront because there won't be any additional fees unless you miss payments," he says. "One fixed payment for a period of time is good from a budgeting point of view."
If you are a homeowner , you could consider shifting the debt on to your mortgage. In theory this is a sensible idea as the interest charged will be lower than on other forms of borrowing, but there are issues, points out Mr Modray at Candidmoney.
"The downside is that remortgaging is often an expensive inconvenience, especially since many competitive mortgages now charge high upfront fees," he says. "If you can shift to a better rate than your current mortgage, you may still save overall within a couple of years. But take time to understand exactly what you'll be paying and whether you'll be locked in via exit penalties."
You must also remember that the mortgage is secured on your home. This means that if you end up not being able to afford the repayments, you face the prospect of losing your house to the lender. So take everything into consideration to ensure such a move makes financial sense.
For example, the monthly payment on a £120,000 mortgage over 20 years, at a rate of 2.39 per cent, would be £629.47, according to figures compiled by broker London & Country. This means the borrower would end up repaying a total of £151,072.80, with the interest accounting for £31,072.80.
Adding a further £20,000 to that debt would push the monthly payments up to £734.38 and the total repaid to £176,251.20, of which £36,251.20 would be interest. Therefore, borrowing £20,000 over this period would cost £5,178.40 in interest.
There are, in conclusion, plenty of ways to tackle a financial crisis but opting for the services of a payday lender should be avoided at all costs, adds Mr Modray. "If you fail to repay on time, you could soon find yourself drowning in debt as you roll from one loan to another while being charged extortionate interest," he says.
Plan for the future
Hopefully your financial crisis will be short-lived and, with careful management of debts and strict adherence to a budget, you will soon be back in the black. When you are, it will make sense to put a safety net in place to guard against future problems, says Mr Chesterman.
"Prevention is better than cure. Even if you haven't got a problem at the moment, it's worth drawing up a budget that includes all your current expenditure as well as items you need to save for, such as car tax, and some money set aside to cover household repairs and future expenses."
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