The most effective way to ditch debt is slow and mundane and begins with the phenomenon we love to hate - budgeting, writes Caroline Madden
ONCE AGAIN, many of us are nursing financial hangovers after the ritual excess of the festive season. Current accounts are overdrawn and credit cards are maxxed out.
Tempting as it is to chuck unopened credit card statements and unpaid bills into the recycling bin, the inevitable cannot be postponed forever. So why not start off 2009 on the right foot and pencil in a debt detox on your list of new year's resolutions?
Unfortunately there is no magic solution to make all of your debts instantly disappear.
The most effective approach to ditching debt is relatively slow and mundane and, dull as it may seem, the key tool is budgeting. By drawing up a weekly or monthly budget listing your income and all of your outgoings, it is possible to identify and cut back on unnecessary expenditure, thus freeing up disposable income which can be used to start tackling debts.
The general rule of thumb is to target short-term, high-interest loans first, such as credit card debt. Also consider temporarily diverting money flowing into a savings account towards paying off costly borrowings. There's little point in topping up a savings account on which you're only earning 5 per cent, if you're struggling to pay off a hefty credit card bill on which interest is racking up at 15 per cent.
With credit card debt, it's also important to beware of the minimum repayment trap. If, for example, you now owe € 4,000 on your card and only pay the minimum amount every month for the rest of the year, you could still owe € 3,500 by next Christmas, so pay off as much as you can possibly each month. Also consider switching the balance owed on your existing card to a new provider offering a zero per cent introductory interest rate. Remember, though, that this strategy is only effective if you pay off the debt within the introductory period.
Overdrafts are a very flexible form of short-term debt that can help with temporary cashflow difficulties. However, overdrafts must be cleared within the time limits set by the bank and ideally, they should be cleared as quickly as possible. The interest rate charged on the amount overdrawn can reach double digits and a surcharge interest rate of between 6 and 9 per cent is often charged on top of this if the authorised overdraft limit on the account is exceeded.
So make sure that you are aware of your limit and what charges apply to your account.
If you have a personal loan, could you afford to pay it off early? Personal loans usually last for between one and seven years and interest rates tend to range from 8 to 12 per cent. As with most debts, the faster you pay them off, the less they will cost you. If you have a variable rate loan (ie the interest rate can fluctuate over the term of the loan), then the option of repaying it early, either by increasing your regular repayments or with a lump sum, should be open to you. However, if the loan has a fixed interest rate, then you will probably face a breakage fee if you wish to repay it early.
Your mortgage may seem like an insurmountable debt mountain that you expect to be still trying to scale when you're old and grey, but there are ways of reducing the lifetime of your home loan and saving thousands in interest repayments.
If you are on a variable rate mortgage and have benefited from interest rate cuts, instead of pocketing the savings, consider maintaining your mortgage repayments at the previous higher level.
Or, if you have enough wriggle room in your budget, consider overpaying your mortgage, for example by making one extra payment a year. However, as with personal loans, if you have a fixed-rate mortgage, you will have less flexibility in pursuing these strategies.
If your financial worries are more serious than a few nasty credit card debts or a stubborn overdraft that you're struggling to shift, and if you find yourself trapped in a debt spiral, the most important thing is to face up to the seriousness of the situation.
Rather than burying your head in the sand, you should seek help as soon as possible. The Money Advice and Budgeting Service (www.mabs.ie) provides free confidential advice to people with serious debt problems. The service has at least one office in every county in Ireland, so contact your nearest office immediately, or call the Mabs helpline on 1890 283 438.
It's also important to accept that there is no shame in getting into debt. It happens to the best of people and very often is caused, not by reckless spending, but by events beyond their control, for example an illness or death in the family or losing their job.
If your debts have spiralled out of control, consolidating them all into one loan (or rolling them into your mortgage) may seem like the solution to all your problems. While it may well result in one lower monthly repayment, over the life of the loan it is likely to cost you more. If your debt consolidation loan is secured against your home, then if you miss the repayments on that loan your home could be at risk
Don't be tempted to resort to other extreme "solutions" such as using credit cards and loans to cover your mortgage bill. Using expensive short-term credit to service a mortgage in this way only compounds the problem. Borrowing your way out of debt doesn't make sense: if you're in a hole, stop digging.
The best way to escape a debt trap is to draw up a budget plan and then list all of your debts, from "secured" debts such as a mortgage, which is tied to your home, to "unsecured" (ie not tied to any particular asset) lifestyle debts such as credit and store card bills. Don't forget to include hire purchase debts, personal loans, overdrafts and any unpaid utility bills.
Then decide which debts should take priority by considering the consequences of getting into arrears on each of them. For example, if you don't pay your electricity bills, it is only a matter of time before you'll be digging out the candles. If your mortgage payments are overdue, you risk losing your home and if you fail to pay certain fines, you could face imprisonment.
Work out how much you can afford to pay to each of your priority creditors each month and be disciplined in sticking to this, even if it means making fairly drastic cutbacks to your lifestyle. Once you have your priority debts under control, work out a programme for chipping away steadily at your less urgent debts, targeting the most expensive short-term borrowings first.
If you are struggling with loan repayments, or have already fallen into arrears, contact your creditors to let them know. A sample letter is available on www.mabs. ie. Explain the reason for any missed payments and ask them for some breathing space. Be upfront and honest - explain that you are in financial difficulty and send them a realistic budget showing how much you can afford to pay each week or month.
If you are back on track with your regular monthly repayments, but cannot afford to catch up on arrears immediately, ask them to be flexible about this.
For example, suggest that they let you spread the missed payment over the next few payments. The good news is that most lenders are far more interested in finding a mutually agreeable solution than pursuing borrowers through the courts.
Once you have succeeded in gaining control over your borrowings, why not try to kick your credit habit altogether - or at least minimise your dependency on debt?
Reducing your reliance on borrowings will not only free up more disposable income, as you won't be wasting money on unnecessary interest repayments, but it is one of the few ways of insulating yourself from whatever twists and turns the economy may take in the year ahead.
Four top debt-busting tips
WANT TO avoid slipping back into your old credit-fuelled lifestyle in 2009? These tips should help to keep you on the straight and narrow.
• Get the scissors out: you may have had some great times together but cash is now king so it's time for you and your flexible friends to go your separate ways. Don't just lock your credit and store cards away - chop them up into tiny pieces. If you must have some plastic, make it a laser card - if your account is bare, it won't work.
• Say goodbye to your "buy now, pay later" mentality: consider saving up for big-ticket items you really want. This may seem like an alien concept at first, but you'll be far less likely to make regrettable impulse buys - and you may come to appreciate your belongings more than in the "easy come, easy go" boom times.
• Think twice before topping up: strictly speaking, mortgage top- ups should only be used to make home improvements that will add to the value of your property, rather than a holiday in Hawaii or a sporty set of wheels. And with house prices continuing to fall, releasing equity in your home increases the risk of finding yourself in negative equity territory.
• Forget about keeping up with the Joneses: extravagance and ostentation have become passé in these recessionary times, which should make it easier for reformed credit bingers to stick to their new year's resolution.
