Road to Wealth #3 - Debt: The Good, The Bad and The Ugly
💸 Today, we tackle the often misunderstood and stressful topic of debt. Financial Planner Abigail Banks leads us in the discussion of the different types of debt that women face, as well as strategies for paying it off and avoiding common misconceptions. Whether it's student loans or mortgages, we provide tips and advice for effectively using and managing debt at every stage of life.
We also discuss the types of debts you should steer clear of and provide resources for obtaining support on your debt repayment journey.
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“Student loans would be the last purely because, again, it’s more like an income tax rather than actually a debt. And if you lost your job, for example, you wouldn’t need to keep paying off that student loan. It would just stop until you started work again and started earning about the threshold. ”
THE DIFFERENT TYPES OF DEBT
The first is student loans. It’s not really a traditional debt. It is more of a tax on earned income above a certain threshold because until you earn above the threshold set by the government, you don't need to stop making any repayments on that. Furthermore, it will ultimately be written off after a certain period of time. It also doesn't impact your ability to borrow or your credit score. It does impact your income because, naturally, a percentage of your income is being taken before tax to pay off the debt.
Then there is unsecured debt, so this is things like credit cards. These are not secured against an asset like a property or covered by a guarantor. So, for example, your house can't be repossessed if you don't meet the repayments on the credit cards.
However, the credit card company could take legal action or seize your belongings if you fail to meet those repayments.
There's also secured debt. For example, a mortgage. This is where the lender takes a legal charge against your property. They’re usually very long-term. If you fail to keep up with the payments on a mortgage, your home is potentially at risk and could be repossessed.
The last one is informal debt - if you take a loan from a parent, for example. They can take you to small claims court should they feel you aren’t paying them back enough.
getting started with paying it off
If you are struggling with debt or have a higher balance of unsecured debt, like credit cards or overdrafts, these should be prioritised. But if you don't have a lot of extra money, how can you actually get started?
It really comes down to budgeting and prioritizing certain outgoings. This affects discretionary spend, like holidays or eating out.
Tightening your budget for a little bit will allow you just to start making a good dent in that debt or overdraft.
As you start working to that budget within a couple of months, it will feel like this is your normal pattern of expenditures. It is just starting, and then it will become a kind of habit to do it.
There are also a lot of debt charities that are actually brilliant if you need some support and help you put in place la repayment plan.
When it comes to prioritising repayments, the priority is always mortgage first. That's really because if you can't or don't pay your mortgage, your house may be repossessed. And if you have a young family or dependents living with you, that's a really serious position to be in.
After that it is credit card. The interest rates are very, very high on a credit card if you're not on a 0% balance.
Student loans would be the last purely because, again, it's more like an income tax rather than actually a debt. And if you lost your job, for example, you wouldn't need to keep paying off that student loan. It would just stop until you started work again and started earning about the threshold.
debt misconceptions and financial planning
Debt has negative connotations associated with it, and probably rightly so in some circumstances.
Debt is actually another tool that's in your kit to be used alongside savings, pensions, etc. It's really not appropriate for everyone, and it always comes down to affordability, but it can be really helpful.
The primary example is buying your first home, given house prices and the increases we've seen over the past 10 years. Speak to a mortgage advisor just to understand your options and the implications of going down a particular route. And even if you don't go ahead, at least you're well-informed and you can make a decision whether it's the right time for you to take on that debt or not.
Lastly, credit cards also have bad connotations, but you can get some really attractive benefits as long as you manage that debt and pay it off every month. You can build up air miles on certain credit cards, and you can build up a really strong credit score because what you're evidencing is that you can take on debt and pay it off each month.
You really need to stop and think, ‘do I need these items and can I actually afford to pay off this debt?’, And if you can't, probably don't, don't go through with it.
Your financial goals vs. debt is a real balancing act. Firstly, it’s about trying to identify what are your short, medium and long-term objectives. A really helpful way of doing this is by looking at some cashflow forecasting.
Perhaps paying off a mortgage if you want to pay that down in the short term, saving into a pension for long-term. You can really allocate your income to meet those objectives that you set out for yourself.
If your interest rate is at 5%, say inflation's at 2% and the cost of investment is going to be 1.5%, you need to achieve a return of 8.5% just to break even, and then the risk is that you'll need to take on from an investment point of view to achieve that consistently — it's very high. For most people that's outside of their natural tolerance for taking on risk. Nine times out of ten, paying off the debt is the most cost-effective way and the lowest-risk option.
how to keep your motivation going
First, it’s important to have a cash emergency fund. Between 6 and 12 months of expenditure. If that's not possible for somebody, just even a little bit of cash aside, just to start building it up over time is really important. It just means that if unexpected expenses do come up, you can use your emergency fund to cover those rather than having to pay it from income.
Then looking at the motivation in becoming debt free — how amazing is it going to feel when you've got a fully paid off house, for example, or you pay off your credit card, you're going to feel so fantastic having that debt lifted off you.
It comes back to that habit. It will become a really normal pattern of expenditure. You won't even notice it if you set that budget.
Then there is discussing things openly and supporting each other (within online communities or friends). It reminds you that you are not alone. It also just gives you the motivation to keep going. You can also share kind of tips with each other.
For example, if you've found a really great budgeting tool, you can share it with a friend and it will help them on their journey.
Then, you should never be ashamed of your debt and it's not a permanent state of being. People get into debt for all kinds of reasons. It might be they've gone through a relationship breakdown, and they need to take on some debt to help them leave that relationship, for example. Just speaking to friends and family, you just get that emotional support and it, it will kind of normalize it as well for you and realize it's probably other people going through it as well and it'll make you feel so much better.
Lastly, there are some really great helplines out there. They're going to be completely impartial and non-judgmental.
For example, if you have a really high-interest rate debt, and you were really stressed about it, you know, a family member be willing to give you a loan to kind of ease that. So it's just having those discussions, um, and trying not to feel embarrassed about it because everybody gets themselves into through situations, and it's never as bad as you think it is.
To summarise, Abigail recommends awareness and learning about the true costs of various debts, understanding which ones to prioritise first, and being open to seeking help and speaking to charities if need be.
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ABIGAIL BANKS
Abigail Banks (LinkedIn) is a Senior Chartered Financial Planner at The Private Office and has been working in the industry for seven years. She provides advice to private clients across a range of financial planning areas including investment advice, retirement planning and inter-generational planning. Abigail is passionate about inclusivity in financial services and particularly enjoys working alongside women to ensure they have the confidence to take control of their finances.
RESOURCES
StepChange: https://www.stepchange.org/
National Debtline: https://nationaldebtline.org/
CitizensAdvice: https://www.citizensadvice.org.uk/