A reader asked:
“We went to see a mortgage adviser to check if we qualify for a mortgage. We are first time buyers, me and my husband have 4 credit cards each and loans.
Because we have a lot of debt, he advised us to go to our respective banks for debt consolidation by taking up a loan each to make one payment on all our debts. He said that was the best option for now. Also in that way we would be able to start saving up as we want to put at least 10% or more for deposit.
I agree because we just find ourselves paying interest on credit cards and the balance isn’t going down. But I’m a bit wary about this as it might put a strain on my credit rating. What do I do? “
That rang lots of alarm bells for me, so I asked some questions about their incomes, details of their debts and whether they had PPI:
“We have a combined income of 45K. My loans and credit cards add up to 22k. My husband has nearly finished repaying his £245/month loan – next year. He also has £7k on credit cards and has just taken a car finance. £186 a month for 5 yrs. We have card protection on the cards.”
In that case I think the advice to consolidate their debts is very poor. I hope the mortgage adviser is better informed about mortgages than he is about unsecured loans…
Consolidation isn’t going to work
People with large debts would often like to consolidate and simplify their debts, exchanging expensive credit card debt for a single cheap loan.
Even though consolidation sounds such a good idea, in practice both of this couple have a lot too much debt for it to be possible. An application for a consolidation loan will just be rejected and that rejection will also harm their credit record, so it’s best to avoid it.
Consolidating the husband’s debts would be foolish even if it was possible. With a large loan finishing in a year, refinancing it over a longer period would result in him paying much more in interest.
What about saving for a deposit?
I’ve written about the problem of balancing saving for a house against paying off debt . But this couple’s debts are so huge they have no option. With debts that are nearly as large as their incomes they don’t have a hope of passing the mortgage affordability criteria even with a big deposit.
Debt clearance has to be their top priority for the next few years. Only when that is well underway should they even think about starting to put money aside for a deposit.
What’s the alternative?
It’s going to take determination to first clear the debts then save that deposit – it’s going to be a tough few years for this couple to get their finances turned round.
A possible plan for the two of them would look like this:
- stop using the credit cards right now. Cut them up! If you can’t afford something out of this months wages you either go without or save it up till you can. This also means stopping using catalogues and Paypal if that is being paid by credit card.
- look closely at where your money is going, keeping a spending diary for a couple of months. Check out this “money detox” program and see where you may be able to make savings
- consider paying for most things in cash for a few months whilst you are working out your budget. Most people find it much harder to hand over ten pound notes than to tap their contactless card on a screen.
- consider cancelling the PPI on all your cards. It is horribly expensive and this is making it much harder to paying off these debts.
- set up standing orders to make payments to each credit card that is slightly more than the payment last month. Because you are stopping the PPI cost, this will mean they are going to drop a lot faster every month. See Fixing your credit card payments for more details.
- when the husband’s large loan finishes next year, look at all your credit cards and decide which one to target first, then pay an extra £200 a month off that one. Ideally choose a card which has a low balance (so it goes soon) and a high interest rate (so you are saving more by clearing it). When you clear a card, phone up to close it unless the card can offer you a good 0% balance transfer deal.
- read up about PPI reclaims. The main lenders have helplines so you can call them up for any card or loan you had even if you don’t remember the account number, to see if you ever had PPI. Any money you could get back here gets paid straight off the card with the largest interest rate.
Both of them are going to have to be fully committed to doing this – if one of them is half-hearted and still carries on using their credit cards this isn’t going to work.