Get Me Out of Debt : Debt Management
The Debt Problem
Uncontrolled consumer debt is a rapidly growing problem. Writing for MRZine.org (http://mrzine.monthlyreview.org/wolff151005.html) in 2005 Rick Wolff reports: "There is no precedent... for the level of personal debt now carried by the American people... by 2004, it reached $9,709 billion. For the second quarter of 2005, the Fed announced that the nation's debt service ratio... was 13.6%, the highest since the Fed began recording this statistic"
The BBC reports that a record number of people in England and Wales went insolvent between July and September 2006 (http://news.bbc.co.uk/1/hi/business/6110722.stm), while according to a 2006 BBC documentary (http://news.bbc.co.uk/1/hi/programmes/panorama/5142492.stm) there were 17 debt related suicides across Britain in the last 3 years.
Causes of Debt
The root cause of debt is living beyond your means. The Dickens character Mr Micawber sums it up nicely in David Copperfield: "Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery." It's surely no coincidence that Dickens' father was imprisoned for debt.
These days lending institutions seem to be falling over themselves to offer credit to all and sundry with little regard to their ability to repay. Unfortunately the glossy offers of vast spending power soon turn to misery once borrowers realize the difficulties they are in. If matters go too far bankruptcy is often the only escape, but this can have a devastating effect on the prospects of the bankrupt for years to come as well as pushing interest rates even higher for those borrowers who do make their repayments on time.
The trouble is that the world is so full of slick advertising and smooth-talking salesmen offering us paradise on easy monthly terms it's all too easy to become trapped in the spider' web of debt.
Good Debt, Bad Debt
Of course there are "good", even unavoidable, debts. For example, few of us could afford a home without the benefit of a mortgage. Similarly, few businesses are able to get started and/or expand without loan finance. Such debts are justifiable, but one should carefully question one's motives before incurring debt for luxuries such as a new car, latest widescreen TV, or a few days holiday in the sun.
Debt Free Living
The golden rule for luxury purchases is to live within your means. If you can't afford the latest hi-tech wizardry, then go without until you can. After all you've managed to get through life thus far without it, so surely you can manage a bit longer.
Living within your means requires careful money management. Be aware of how much you have coming in, and how much you are spending. How often you do this is up to you. Once a week is ideal, any less frequent than once a month could be asking for trouble.
Hopefully you will find that your income exceeds your outgoings, if so, congratulations! Now look for a home for your surplus funds. This will depend on your financial goals and your attitude towards risk. A copious amount of advice is available on this site and elsewhere.
But what if you find your outgoings exceed our income. Once again congratulations! It's a problem, but at least you've discovered it and can take steps to do something about it.
Start by carefully examining the outgoings side of the equation. Are there areas that you could cut back? Some typical examples might be making a sandwich in the mornings instead of buying lunch outside, canceling non-essential subscriptions, making sure that, where there's choice over things like utilities and telephone service, that you're getting the best deal.
How about the income side? Do you have an opportunity to make part-time earnings? Perhaps you could turn a hobby into a valuable income source, or maybe there's an opportunity for overtime in your existing employment.
Debt – Finding the Best Deal
So, you’ve carefully considered the pros and cons, and you’re personal balance sheet, and concluded you can justify taking on a debt. Your task now is to find the best deal. The good thing is that there are numerous lenders falling over themselves to lend you money. Though this can be a minefield for the unwary, this places the savvy borrower in the driving seat.
Always compare the APR (annual percentage rate) in comparing deals. Lenders have all manner of clever ways of calculating rates to make them seem more attractive. APR places everything on a level playing field.
Beware of hidden extras. For example, is there a penalty for early repayment? The cheapest rates may come with strings that require you take certain insurance policies from a certain provider. These may be more expensive than you could find elsewhere, or in the worst case may be unnecessary. Take these into account as they often mean the “best” rate isn’t really best.
Beware of store cards. Sales assistants are programmed to push these with every purchase with the promise of discounts if you take one out. The problem is that once you start using them the interest rates usually far exceed those charged on standard credit cards. If you're offered a $20 discount for taking out a store card, then by all means do so - just make sure you don’t start using it for genuine credit purchases else you will end up paying far more than the price o the tag.
Here are just a couple of examples where sales people prey on fear and unnecessarily increase your monthly outlay:
Extended warranty insurance is invariably offered on the purchase of electrical/ electronic goods. With most such goods you already get a legal warranty period - usually a year - free of charge. If anything's going to go wrong it will most likely do so within this period. If the goods prove themselves robust enough to survive the statutory warranty, chances are they will keep going for many years. Put the money you would have spent on extended warranty premiums in a high interest savings account instead. Chances are that if anything does go wrong you'll cover it from savings, and if they don't, you'll soon accumulate a tidy little sum.
Payment protection insurance is frequently offered with any kind of loan. It is supposed to cover the costs of the loan should you lose your job or fall sick. Its primary purpose is to protect THE LENDER. However a big problem with this is the number of exclusions it has, eg it probably won’t apply if you're a freelance or fixed-term contract worker, or if your sickness is due to a previously known health condition. It can also be expensive considering the costs, potential benefits, and probability of ever drawing from it. If you are still considering taking such a policy enquire if it must be taken with the loan provider. If not, shop around for the best deal, eg via the Internet.
Debt Management – Reduce Debt, Eliminate Debt
But suppose you've already amassed a stack of debts. Is there any way back from the brink? Very possibly there is.
The first thing to do is to prioritize the debts. A useful way to do this is by considering the worst-case scenario of non-payment. If the consequences are jail or losing your home, then sort those debts first.
Next, identify the debts with the highest interest rates and clear these first.
Can you move your debt to a cheaper source? For example transferring credit card debt to a personal loan or overdraft? Check the APR of the different sources and the factors mentioned above before making a decision.
There's a growing number of commercial institutions that will help sort out your debts for a fee. They will, for example, negotiate with your creditors to freeze interest and arrange an affordable repayment schedule. You avoid bankruptcy and they eventually get their money - so everyone wins. Or do they? These institutions charge fees for their services, which will eventually come out of your pocket.
I wouldn't say never touch such institutions, their experience of negotiating with creditors as an impartial 3rd party can be useful, but I would certainly investigate alternative avenues before signing up with one.
Given the growing problems of debt there's an increasing number of voluntary / non-profit advice agencies which can perform similar functions to the for-profit institutions mentioned above. For example: