After university, give debt the third degree

Sam Dunn reports on how graduates can repair their finances

A popular stunt on graduation day is to photograph former university students as they toss their mortar-board hats high into the air. But after the celebrations, they might feel like passing the hat round. As they take their first steps in their careers, graduates will be weighed down with an average debt of more than £12,000, according to the National Union of Students.

This will have a lasting effect, warns Jeremy Law, head of graduate banking at Barclays. "Graduates are saddled with debt for longer and unable to get on the housing ladder or make appropriate pension provision until much later in life."

However, while being in the red is the accepted bane of most graduates' lives today, it doesn't have to cripple their finances if they tackle it head-on.

To this end, many of the big banks offer graduate accounts aimed at easing the switch between student and working life, although look beyond incentives such as discount vouchers (Barclays), commission-free currency (NatWest) or free breakdown cover (Lloyds TSB). As a graduate managing a monthly income for the first time, it is more important that you're happy with your bank's customer care.

You may not have enjoyed a smooth relationship with your lender as an undergraduate, and if so, no one will thank you for being loyal now. Many graduates stay with the same bank they had during their student years, either through apathy or because their debts are so large they feel no other bank will take them on. This isn't the case. You may be knee-deep in debt after years of student borrowing, but other banks will be keen to take you on as you're likely to be a valuable customer in the future and buy mortgages, loans and savings products.

You should also consider how best to manage your likely overdraft. Most banks will offer an interest-free overdraft for at least three years, but watch out for tiered limits. For example, Lloyds TSB's graduate accounts let you run £2,000 into the red in the first year without charge, £1,500 in year two and £1,000 in the third. If you struggle to clear debt with your monthly salary, however, you'll pay interest on any amount over these limits.

You can arrange an authorised overdraft with a lender to avoid stiff penalties, but interest charges vary between banks, so compare the different rates.

According to figures from the information provider Moneyfacts, one of the highest charges is 17.81 per cent, at NatWest. Both Lloyds TSB and Barclays levy more than 15 per cent, while Abbey charges 8.7 per cent.

Try not to breach your authorised limit: one-off penalties and high interest await if you do. In Abbey's case, you face a £20 fine and interest of 27 per cent.

In any event, your account should have an interest- or fee-free overdraft buffer to protect you against the occasional slip into the danger zone - but check to make sure.

Not everybody will be able to chip away at their debt quickly. According to Barclays, the average starting salary for graduates is £17,394, but many will be on considerably less or start off in temporary work.

"Graduates should pay off the debts with the highest interest rates first," says Mr Law.

One option is to clear your overdraft by taking out a graduate loan and repaying this in more manageable monthly sums. A £4,000 loan repaid at an annual percentage rate (APR) of 8 per cent should compare favourably, depending on the length of the deal, with a bank overdraft for a similar amount at more than double this rate.

On such a loan, Lloyds TSB charges from 6.9 per cent, Barclays 7.9 per cent and NatWest 8 per cent, although, in the case of NatWest, graduates using its loan expressly to settle their overdraft won't pay any interest at all.

All three banks offer repayment holidays, usually of up to four months, but remember that the extra interest will be tacked on to the cost of the loan.

Not all banks offer a designated graduate current account. The Co-op, for example, extends the terms of its student account package for one year, but after this, you'll be switched on to its normal current account. Here, you'll be charged an £8 monthly fee for an overdraft as well as a separate "usage" fee.

Generally, as long as you keep an eye on your spending, you should be able to avoid the wrath of your bank and end up whittling away your debt.

In the early days at least, keep it simple and try to monitor your income. "It's dull but making a budget is essential to prioritise your spending," says Ann-Marie Blake, head of graduate accounts at NatWest. "You'd be amazed at how much is spent on books and magazines and other small things."