A reader, let’s call him Mr B, asked:
If you can more or less repay the minimum payments on your debts, but the minimum payments are 75% interest and the debt level is sizeable, as a rule of thumb, should you be looking at a DMP (or other debt solution route) or keep those minimum payments going while looking to improve your pay/outgoings scenario so as to pay more to the debts each month?
My position is in flux so I am weighing up different possibilities. I see that without the interest I am just about paying, I would potentially be able to pay off quite a lot per month to the debts themselves…at the cost of having a damaged credit record…
He has asked for a “rule of thumb”.
The problem is that it anything that is simple is probably useless!
If Mr B has a partner and a child and is spending £300 a month on groceries (food, toiletries, everything you buy in a supermarket) there are unlikely to be any savings he can make.
If he is single and spending £300 on groceries and takeaways then he can probably cut back a lot.
That is with the same debts, same repayments, so any rule of thumb would give the same answer. But in reality there are two very different situations!
Improving your situation
If you think you can increase your pay and/or decrease your outgoings then that is the obvious thing to try first.
Unless you already budget in detail, it’s always good to keep a spending diary for a month or two. This may just confirm what you already know, that clothes are your weakness or you spend a lot too much on entertainment. But for some people this can be an eye-opener, and knowing the facts gives you a much better idea of what areas to target for improvement.
If your credit rating is good, you could also look at 0% balance transfer deals. There has never been a better time to get a really long 0% period! Use a “soft checker” to see what you are likely to be offered.
There are lots more articles looking at how to boost your finances – see which of them could work for you.
In a state of flux?
Simplistic debt advice looks at your income, expenditure and debts and out pops a neat “answer”. But in real life many people are like Mr B, expecting things will change.
Without a working crystal ball, Mr B may need to take a decision based on what seems most likely to happen:
- if he thinks life is going to be much more difficult when his partner has their second child in January, that’s pretty definite – he even knows the date – and he should start planning for it right now;
- if he is hoping his eldest is going to help with costs when she gets a job, that’s more uncertain as she could decide to leave home!
Sometimes a waiting option may be best. Mr B may decide to go for one approach now even though this probably won’t be ideal in the longer term because if he takes a firm decision now he could regret it later. So struggling on with the debt repayments now may be a good idea if there is a realistic chance things will improve in a few months.
If your finances aren’t going to remain the same, one debt option that is usually best avoided is an IVA because it is a long term commitment which isn’t very flexible. If your position gets worse your IVA may fail and if it gets better you may regret ever having started it!
How much does your credit rating matter?
If you think there is a serious chance of clearing your debts and saving for a house deposit in the next few years then protecting your credit rating is important. But you aren’t going to get a mortgage if you have a lot of debt.
Be honest with yourself – if you pay a chunk off that credit card, is your overdraft just going to get bigger? I you don’t think you can ever clear your debts by making the normal payments, you have to find a debt solution even though it will harm your credit rating. If you don’t, you are going to be in the same situation in five years time – lots of debt and no closer to buying a house.
Get more facts to help with the decision
When there isn’t a simple answer, a general rule of thumb approach may not be right for you and you don’t know what the future will bring it can feel hard to make progress. Wait and see isn’t always a good idea though, even if it feels easiest. For many people getting a couple of “hard facts” could help them make the right decision:
1 How long will it take to repay your debts without a DMP?
This could be longer or shorter than you think. If you will be making the last payments to a loan next year, from that point you will be able to pay off the credit cards much faster. But if you are guessing your credit card will be cleared in about four or five years if you make the minimum payments, it won’t, it will take much longer!
So don’t guess, put all your debts into this repayment calculator and see how long it says.
2 Is a DMP a realistic option for you?
If that debt repayment time seems too long, talk to StepChange about a DMP. (StepChange are a charity. If you say you don’t want to set up the DMP immediately you won’t get a “hard sell”, you won’t get bombarded with calls, texts or have your details sold on.) They will go through your situation and say:
- if a DMP is appropriate and what you would have to pay to it each month;
- what your other options might be.
Mr B is assuming that if he goes for a DMP his creditors will freeze interest. If that happens his debts will indeed drop much faster. But if StepChange say he isn’t suitable for a DMP as he can afford the normal repayments, then it’s likely that his creditors wouldn’t agree to freeze interest. If a DMP isn’t realistic, then cross it off your list for now.