Wealth Check: 'How high can I climb on the London housing ladder?'

The patient

After struggling to get a toehold first time round, Karen Smith, 29, is keen to move up the property ladder.

She bought a one-bed flat in Brockley, south London, 18 months ago for £156,000, taking out a 100 per cent interest-only HomeStart mortgage with HSBC. This costs £700 a month and is fixed until February at 5.39 per cent.

"It was tricky getting on the ladder but I inherited £10,000 from my grandparents, which was a start," says Karen. "After making some improvements, the flat is now worth about £250,000."

She hopes to trade up in the next five years to a two-bed flat in the same area.

Karen earns around £40,000 as a graphic artist. "I work full-time but I'm not staff so have no contract," she adds.

After spending all her spare cash in buying the flat, Karen has no savings. She has £10,000 in credit card debt split between an HSBC and Virgin MasterCard, both at 15.9 per cent. She also has £7,000 in student loans to repay.

She is keen to clear this debt and put herself in the position of being able to rent out her flat to cover the mortgage repayments if she wants to go travelling, although she has no immediate plans to do so.

Karen does not contribute to a pension and has no insurance, having recently cancelled her income protection policy.

The cure

With an interest-only mortgage, credit card debt and no savings, Karen should avoid stretching her finances any further, warn our panel of independent financial advisers (IFAs).

Debt

Her first priority should be to clear the card debts as soon as possible, and as she is on a decent salary with relatively low mortgage repayments, she should be able to do so.

One option would be to consolidate the debts using a short-term unsecured personal loan. "She can borrow money at around 6 to 7 per cent, which is less than half what she is paying at present, and fix the [loan] term at three or five years," says Anna Sofat of IFA AJS Wealth Management.

A £10,000 loan at 6.3 per cent over three years would cost £305 a month, she adds.

The student loan has a low rate of interest at 2.4 per cent, so Karen can continue to pay this off gradually. The rate, though, is set to rise to 4.8 per cent from September.

Savings/investments

Even if it's just £20 a month, Karen should start putting some money aside, says Mike Pendergast from IFA Zen Financial Services. "She needs something to fall back on should anything unexpected happen."

Property

Choosing an interest-only loan means Karen isn't tackling the capital debt. "She should make overpayments when possible and switch to a repayment plan at some point in the future, rather than rely on equity in the property," stresses Malcolm Lyons of IFA Music Media.

When her fixed deal ends, Karen could face a sharp rise in repayments, particularly if interest rates continue to climb. She should plan ahead for this, says Mr Pendergast.

If she does travel, she should talk to a few agents to see what rental income she may receive. Ms Sofat suggests she needs £875 a month to cover 125 per cent of the mortgage payments. "She should factor in a 12 to 16 per cent agency fee and some spare funds for when the flat may be empty."

Retirement

The contributions made to a pension pot in the early years make the most difference, stress the advisers. Karen should aim to set up a plan and save £100 a month, only costing her £60 after higher-rate tax relief.

As her income rises, she can look to increase this to around 10 per cent of salary, adds Ms Sofat.

Protection

Cancelling the income protection plan was a "bad move", says Mr Pendergast. If she is unable to work because of illness, how will her credit card and mortgage debt be repaid? She needs to consider getting a policy back in place.