Wealth Check: 'Debt is blocking the next rung on the property ladder'
A couple's five-year plan, including a new home and children, is hampered by £7,000 in loans and little equity
Sunday 08 January 2012
Alex Bell from Dewsbury, West Yorkshire, is keen to move into a new house, but needs to get her finances back on track before she and her husband can move to a new-build house.
The 25-year-old works as a senior project support officer in the NHS, earning £24,500 a year. She has been with the NHS for six years, and in her current job for three years. Her husband, Andrew, 30, also works for the NHS, as a contractor earning £23,000.
The couple, who recently got married, have amassed some debts, including £3,000 on a credit card and a £4,000 personal loan. "The card is a 0 per cent deal with Tesco, but the interest-free period is due to finish in May 2012," says Alex. "We are looking to clear the balance before then."
They also have a £4,000 loan with Zopa, an online market place where consumers borrow money from and lend money to each other directly – cutting out the big banks.
"The loan is at a rate of 12.7 per cent," says Alex. "Any spare money we have, we put towards paying off this loan, as we can overpay without incurring a penalty."
At present, Alex has no savings or investments, nor does she have any pension provision. "My employer does offer a scheme and makes contributions, but I am not a member," she says. "As Andrew does not have access to a work pension scheme, he would like to start paying into a private pension."
Alex and Andrew live in a two-bedroom terrace which they bought in 2005 for £89,000. "We have a 100 per cent repayment mortgage with NRAM (Northern Rock Asset Management), and have had this for five years," says Alex.
"The mortgage comprises of a secured loan of £83,694 and an unsecured loan of £5,038. We had been paying these off at a fixed rate, but this deal has now finished, so we are currently paying the standard variable rate which is 4.78 per cent."
The couple also took out a further loan against their mortgage in 2008 which means they now owe a total of £94,597; their monthly payment to NRAM is £500.
The couple are keen to move house in the next five years, and would like to move into a new-build home.
"We have been looking at properties around the £150,000/£180,000 mark," says Alex. "As we have no equity in our house, we will be looking at saving quite a lot for our deposit. Squirrelling money away is going to be our main priority once we have paid off our debts. We are already taking steps to cut our outgoings, such as making purchases through Quidco so we can benefit from cashback."
Both have life insurance policies with Sainsbury's Finance, and pay a total of £6.71 a month; this does not include critical illness cover.
Once they have bought a new house, they would like to plan for children.
Our panel of independent financial advisers (IFAs) agree that Alex needs to think carefully about moving to a more expensive house given her current financial position, as this will mean taking out a larger mortgage – and therefore higher monthly costs.
They recommend she focuses on paying off her existing debts and building cash savings for a deposit, and to start thinking seriously about pension saving and planning for the longer term.
Set targets to repay the debt
Alex should set herself a monthly target of how much she will put aside to repay her debts, says Danny Cox from Hargreaves Lansdown. "This amount should leave her account at the start of the month, as this is a priority," he says. "The target should be big enough to reduce the debts quickly without being unrealistic."
Patrick Connolly from AWD Chase de Vere adds that Alex should work out exactly how much income is coming into the household, and how much is going out. "This will help her understand how quickly the debts can be paid off, starting with the most expensive," he says. "She should also look to reduce how much is being spent by cutting back on luxury spending and shopping around on utility bills."
Kusai Ariyawansa from Appleton Gerard adds that Alex should also address the pattern of acquiring debt.
"Significant debts of this size could derail any future emergency funds and plans," he warns. "A strong financial plan and strong discipline will leave the couple in a better position for both a new house and children."
Save for a deposit
Once the credit card and loan have been cleared, Mr Cox recommends Alex switch this money into savings.
"With mortgage companies typically requiring a deposit of 20 per cent, Alex will need to save £30,000 to be able to afford to purchase a £150,000 property," he says. "Even if a lower deposit of 10 per cent is required, Alex will still need to save £15,000."
He suggests she might want to look at squirrelling away between £500 and £750 a month to achieve this goal.
Mr Connolly points out that the bigger the deposit, the better terms they will be able to secure it on.
"However, as their property hasn't risen in value, they have little equity to fund a deposit – making the target even more difficult to reach," he says. "Plus, as they are borrowing at around 100 per cent of the property value, this gives them little scope to improve the terms of their existing mortgage. They will have to work very hard at saving over the next few years."
Make use of an ISA
As well as saving for a deposit, Mr Ariyawansa says Alex also needs to build up an emergency fund. "Alex should save into a cash individual savings account (ISA), as the rates can be competitive, and interest is tax-free," he says.
Mr Connolly agrees that Alex should have some cash savings. "If nothing else, a cash buffer will mean there is more money to cater for short-term emergencies or requirements, without the need to take on more debt," he says. "A little further down the line, it would also be useful to have longer-term investments outside of a pension, ideally in a stocks and shares Isa. However, in her current financial position, this isn't a top priority."
Join the pension scheme
Despite Alex's debt position, Mr Cox recommends she join the NHS final salary scheme at the earliest opportunity. "The cost to Alex will be 6.5 per cent of her earnings – or £104 a month – whereas the cost to the NHS is around 20 per cent of her earnings, or £400 per month," he says. "Had she joined six years ago, she would have already built up pension rights of £1,800 per year – worth around £52,000. She should not waste this opportunity further. Even if the proposed changes to the NHS scheme happen, it will still be one of the best pension schemes to join."
Mr Ariyawansa agrees that while her take-home pay will reduce by £133 each month, she will begin to accrue very generous benefits. "It is difficult to match these benefits with any private arrangement for the same rate of contribution," he says. "At retirement age, Alex will receive a guaranteed annual pension which will rise with inflation every year. She will also get a 50 per cent spousal entitlement on her death; private schemes struggle to match such generosity."
Think about protection policies
Given that Andrew is a contractor, it would be sensible for him to take out a long-term income protection plan to pay a percentage of his salary as a tax-free income, says Mr Ariyawansa.
"Both Alex and Andrew already have life insurance which covers the mortgage, but ideally this should also cover the loans, and include critical illness cover," he adds. "Being young, premiums should be relatively cheap."
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