Jim asks: “I’ve got into the habit of paying for things with my credit cards, and need some advice on paying down the debt that I’ve built up.”
Q&A 89 – Advice On Debt Repayment – Shownotes
I’m looking for advice on the best method of handling the debt I’ve accumulated, I’m normally quite good and I live a very frugal life but in the past year or so I’ve hit an early midlife crisis and bought a car/splurged out on other things without really paying attention to my spending and got into the habit of paying for things with my credit cards.
• Bank of Scotland – £81.65/Month (23.5% APR | Settlement Amount = £4200 with 52 months)
• Sainsburys – £161/Month (4% APR | Settlement Amount = £4700 with 24 months)
• Asda Money – £1950 (20% APR – Limit 2000) – £52 (Minimum)
• Barclaycard – £1700 (30% APR – Limit 1800) – £54 (Minimum)
• Capital One – £950 (35% APR Limit 1000) – £34 (Minimum)
• Planned Overdraft £1700 (Limit £1900 | £5 monthly charge + £15 interest)
Breakdown of expenditure:
My credit score on noddle is 547 which limits my options, I was debating taking out a loan (18.5% APR) to clear my credit card debts, is this silly?
• Monthly Income – £1320
• Monthly Expenditure – £1000 (including minimum payments)
Thank you for any help.
Jim – thanks for your questions and congratulations for waking up and smelling the coffee. You’ve got quite a lot of debt scattered around there, which you are right to tackle as soon as you can.
Snowball vs Avalanche
The first thing you need to do is list your debts in descending order of their interest rates. This is the order that you’ll be paying these debts down under the avalanche method of debt repayment:
This is easy for all the entries with interest rates, but a little trickier with your overdraft as it is a flat charge. However, I’ve estimated this by looking at the annual charges divided by your outstanding overdraft of £1700 and it comes out about 14.1%. This puts it below Asda Money but above Sainsburys in your repayment order.
Debt Repayment Plan
The next step is to work out how much extra you can pay. Your minimum payments come to £402.65 and you say in your question that you have about £325 surplus each month to put against your debts. Now, to allow for slippage, I’ve reduced that in my calculations to £247.35, so allow you to have a little buffer every month, but also to make a nice round sum total repayment each month of £650.
Next, we need to work on a payment plan. This consists of applying the amount you have to overpay each month to each debt in descending order of interest rate.
So, for the first 4 months, the addition £247.35 goes to the capital one card. Once this is paid off, that £247.35 plus the £34 minimum payment moves onto the Barclaycard. Now, each month, £54 minimum payment, plus this new £281.35 overpayment.
You can see how this would build up every time, causing that avalanche effect which pays down all the amounts more and more quickly over time.
Based on the values you have provided, you would repay all of your loans in 28 months without ever paying over £650 per month in total.
Given that you currently have £15,200 in outstanding debt, I would say that isn’t bad at all.
However, it isn’t necessarily optimal. Over those 28 months, you are still repaying £2,691 in interest. Not cool.
What About Debt Consolidation?
So, what are your alternatives?
The best way would be what many people call “debt consolidation”. This involves taking out a new debt, at a cheaper rate, in order to pay down all of your existing debts.
The following example may not be optimal (0% money transfer cards are usually the best for this), but it will be the simpliest.
A quick search on Money Supermarket for £15,000 loans with an income matching yours, showing a possibility of borrowing at 3.3% APR with HSBC.
If we take out that loan, and use it to repay all other outstanding debt, we would now have a debt of £15,000 and £650 to repay against that loan over time. This would take 24 months to repay.
Therefore, by taking out the loan over a period of 2 or more years, and repaying it in this way would mean you become debt free 4 months sooner. More importantly, rather than paying £2,691 in interest in the original scenario, you’d now only pay £510.50 in interest.
Depending on your credit rating, the £15,000 loan may only be available at a higher APR, but as long as this is less than around 15%, it would still be cheaper than your current situation.
All of these figures used above can be found in the following spreadsheet: Question 89 – Debt Advice.
Hope that helps Jim and that it encourages you, and any other listeners who are currently in debt, to become debt free as quickly as you can.
If that isn’t incentive enough, think about this. With the smart debt consolidation and overpayments, we pay interest of £511 whilst waiting to become debt free. With just the overpayments with your existing debts, you’d pay £2,691.
Can you guess how much interest you’d pay if you only ever made minimum payments? Brace yourself – £12,690. And, you’d be in debt for 139 months. That’s right – over 11 years of your life.
So, get repaying today!
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