Wealth Check: To get out of the red, he would even sell his home
Desperate times, desperate measures. But is there another way and would the sacrifice be worth it? By Harriet Meyer
Sunday 03 August 2008
Despite the housing market slump, Michael Scott, 35, hopes to sell his seaside home and put some of the proceeds towards paying off debt.
He bought his two-bed period flat two years ago for £205,000 in Brighton's Norfolk Square, where many buildings are listed, and reckons its value has risen to £240,000. "The location is desirable," he says, "so it should still be worth a decent sum. And perhaps it's still possible to sell before prices slip further."
Fortunately, he secured a good mortgage deal before the credit crunch began to bite. He took a two-year tracker at 0.13 percentage points below the Bank of England base rate with Nationwide building society a year ago, giving a current pay rate of 4.87 per cent.
He pays £1,000 a month for a 25-year £205,000 interest-only mortgage, and repayments are eased by rental income from a friend who shares the flat. Because his loan is interest-only, Michael is not paying off any of the capital borrowed.
"If I sell, I will probably be forced to rent for a bit before buying again," says Michael, who earns £46,000 as an account handler for a medical communications firm. "But I've not made a firm decision on this yet."
In the meantime, the priority is wiping out £18,000 worth of debt. He has £5,000 on a Barclaycard and £3,000 on a Capital One card, both on nine-month interest-free balance-transfer deals.
He also pays £300 a month for a £10,000 personal loan with Egg at 7.1 per cent over three years, which was taken out to consolidate other debt.
Michael has not managed to make any short-term savings after ploughing all his spare cash into the flat. "But I want to work on boosting my savings now," he says.
However, he has already made a good start in building up a pension pot, with several plans in place from previous employment. He has two stakeholder plans, one worth £10,000 with Scottish Widows, and another at £28,000 with Friends Provident.
"But I'm not paying into these any more," he says. "I'm really not sure what to do with them, so it would be good to get advice."
He has been in his current job for three months but is yet to join the company pension scheme. "I have to be there a year first, and contributions will be backdated to when I joined." His employer will then pay 5 per cent of his salary into the scheme, regardless of how much he contributes.
Reining in spending and avoiding further debt makes far more financial sense for Michael than selling his home in the current climate, stress our independent financial advisers (IFAs).
"If he does sell and pay off his debts, he's likely to be left with less than £10,000 after costs and will have to rent," warns Alex Pegley at IFA Calculis. "This money may be spent quickly, leaving him back at square one, but without a property."
Although he is currently on competitive deals both on his plastic and his personal loan, Michael must aim to wipe out his credit card debt during the interest-free balance-transfer periods to avoid incurring high interest charges. "The next stage is to cut up his cards," says Mr Pegley.
"While he has this level of debt, his options and ability to build his asset base will be limited," adds Anna Sofat from IFA Addidi.
Trying to sell his home and buy another at a lower price, amid the credit crunch and the current housing market turmoil, is a high-risk strategy. "Michael may be unable to sell, and even if he does, the cost of borrowing has risen substantially," says Ms Sofat.
If he does sell, there is only a small amount of equity in the flat and this will be eroded by costs such as stamp duty and estate agent fees. And he could find it hard securing another mortgage to get back on the ladder, as many lenders are asking for big deposits, sometimes 10 per cent.
"It's not all bad news, though," says Mr Pegley. "Period properties in the right place have probably been least hit by the downturn and are also likely to recover fastest." So riding out the credit crunch and waiting for lenders to ease their criteria is a wiser course of action for Michael.
Another issue is that his mortgage is interest-only so he is not reducing any of the capital debt. "The easiest solution would be to convert it to a repayment loan next year when it comes out of the two-year tracker rate," says Ms Sofat.
But based on current rates he could see a hike in repayments of around £250 a month when his deal ends, even on an interest-only basis, adds Jason Witcombe from IFA Evolve Financial Planning. For this reason, Michael should seek financial advice when the time comes to remortgage.
While Michael benefits from higher-rate tax relief on pension contributions, clearing debt should be his priority before he focuses on retirement planning. "But he should still join the company scheme," says Mr Witcombe. "Otherwise he is in effect refusing a pay rise, as it will make contributions on his behalf."
Michael could consolidate his accrued pension pots by moving them either to his employer's scheme or a private pension. "This will simplify things," says Mr Pegley, "and in a private plan he could pick and choose the funds." He recommends Blackrock's UK Absolute Alpha fund, which aims to achieve positive investment returns whatever the economic climate.
However, putting 5 per cent a year into a pension will not provide a decent retirement income. "At his age he needs to pay in at least 10 per cent of his earnings," says Ms Sofat. If he can't afford this, he should try to increase his payments by 1 per cent each year.
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