A reader asked about the best way to clear debt:
“I owe about 12k and my partner a bit more. We are well paid but we can’t rely on the bonuses and we want to get a house as soon as possible. What do you suggest? Preferably easy as we both work long hours – please don’t tell me to take sandwiches to work!”
First well done on taking the decision to do something about your debts. It’s pretty easy to run up the credit cards if you have good but not regular bonuses. Your large debts may be about manageable at the moment, but jobs do go wrong and suddenly your situation could become much less safe. And if you want a mortgage, most of your debts have to go – see Can I get a mortgage with debt?
There are two approaches you could take:
- consolidating your debt so you each have one large loan – this is sometimes called re-financing; or
- snowballing, which is paying the minimum off all your debts apart from one and aiming to clear that one as fast as possible. (Your “snowball” is the amount you overpay a debt each month – this gets bigger as the months go on because you are paying less interest, just as a snowball gets bigger as it rolls downhill and picks up more snow.)
NB both ways assume your current debt payments are manageable – you just want to cut them! And they will both work much better if you have an OK or better credit record. If you can’t manage your current debt, check out a simple overview of debt solutions.
Debt consolidation – temptingly easy?
Debt consolidation sounds so simple – exchange all your current debts for a single loan and a single monthly repayment. After a few years, at the end of the large loan, there you are, debt free…
It’s not so easy in practice.
You may not be offered a large enough loan to be able to repay your other debts. Even if your credit record is really good, you may be refused if the lender thinks this loan plus your existing debts would be too much. You know you want to repay the other debts, but the lender may reject your application because they can’t be sure you would. See What to do if a consolidation loan is refused for more details.
And if you do get the loan, a lot of people clear their credit cards but keep one or two credit cards open “for emergencies” and then over time just run up the credit card bills again… If your income is erratic, it may seem obvious to use the cards to smooth it out, but that is a slippery slope, it’s how you got your current debts. In a year or two you may find you have the large consolidation loan AND a lot of new credit card debt.
So far from being an easy way forward, a consolidation loan often ends you up in a much worse debt situation.
Don’t consolidate debt with a “bad credit” lender
If you have a lot of high-cost debt already, you should never ever try to take a single loan from a bad credit lender to consolidate it. These are lenders such as 118 Money, Everyday Loans, Likely Loans, Avant Credit, TM Advances etc. They may sound cheaper than your current borrowing, but their loans are expensive and go on for a very long time.
As a debt adviser I see far too many people who thought a simple loan from one of these lenders would solve their problems, but actually it just got them deeper into debt. Here is what one reader said of one of these loans:
I had a loan of £2,000 that I repaid early after 6 months with a loan from my parents to save in interest. It turns out the figures to settle was £1,999.42, despite paying £958.02 to them already I had only actually paid off 58p of the loan, I was gutted.
If you have payday loans you can’t afford to repay without borrowing, you need to halt this debt trap by asking the lender for a repayment plan and also making a complaint about unaffordable lending, see How to ask for a refund for payday loans for details.
Never consolidate debt with a guarantor loan or a logbook loan
If going for high-cost loans to consolidate is dangerous, using a logbook loan or a guarantor loan is much worse.
With a logbook loan from companies such as Varooma, Loans2Go, Carcashpoint, Mobile Money, Logbook Loans and Auto-Money then you are trapped as if you don’t keep up the payments you may not even be able to get to work.
A guarantor loan from lenders such as Amigo, Bamboo, George Banco and Buddy Loans can turn into a nightmare as any problems you have will harm your friend or relative.
These are loans that should be avoided at all costs!
2017 is a great time to “snowball your debts”
Snowballing is described in detail in this guide. It is more complicated because you have to decide what order to tackle your debts in and every month decide how much you can afford to pay off your top target debt. And snowballing efficiently means keeping an eye open for good balance transfer offers to reduce the interest you pay.
The good news is that at the moment there are a lot of very long 0% balance transfer offers available – 43 months from a couple of lenders! If you both could grab one of those, you could turn it into a three-year interest-free loan by repaying a fixed amount each month, which would be a simple way to really kick-start your debt reduction plan. If you use this soft-search checker, it will tell you which balance transfers you are likely to be accepted for – you can’t get much easier than that!
Which will work better?
If your income is secure and fixed and you have the willpower to never use a credit card again, then debt consolidation works fine. But snowballing is a more flexible, practical approach for most people. In a good month you can overpay a lot – you could aim to use all your bonuses for extra debt repayments. In a bad month you won’t be able to pay off so much, but you still make some progress.
About those sandwiches…
Of course, you don’t have to take sandwiches to work. Or cancel Sky, go on fewer holidays, give up the gym, hang onto the car for another few years, go out less often or cut back on gadgets and clothes. But then you don’t have to save up a house deposit, put money away for a pension or plan to have a family either!
Most people, even with good incomes, have to make some hard choices. Only you can decide what you really want, but make this an informed decision, don’t just drift along. Try keeping a spending diary for the next month and see where the money goes, then decide if you want to make any changes.