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Paying off expensive debt

3 Sep, 2020

By Cherry Reynard

What is expensive debt?

This is a good question. After all, a lot of debt might not feel expensive if you pay it back over a long period of time. Expensive debt is where you pay back a whole lot more than you borrowed. You can gauge whether debt is expensive by looking at the interest rate – remember the Bank of England’s overall interest rate is zero. If you’re paying 50%, chances are, you’re being fleeced.

There are different tiers of debt. Mortgage debt is usually the cheapest and is often as low as 1-3%. You pay it back over a long time, so it doesn’t feel that expensive. The next tier is usually personal loans, where you’ll pay 3-6%. This moves higher for credit cards, which are usually 10-20%, but some can be vastly more expensive. At the top of the heap are overdrafts, which can top 50%.

Payday loans are a whole different ball game – vastly expensive with huge interest rates. They are only if the bailiffs are knocking at the door and even then you may be better off taking chances with the bailiffs.

Dealing with expensive debt

First goal, stop it getting worse. If you’re only paying off the minimum each month, you can pretty much guarantee that your overall debt is increasing. The maths is unarguable. You’ve got a £1200 debt, for which you’re charged interest of 10%, you’re paying £120 a year or £10 a month. That means you need to pay off more than £10 a month to reduce the debt at all.

Then, quantify all your debt and look at which debts come with the highest interest rate. That’s the one you’ve got to tackle first. Consider consolidating into a single loan, or even a 0% balance transfer credit card. You’ll pay a transfer fee, but it should work out far cheaper in the end. The interest period may be time-limited, so make sure you pay it down before the rate jumps higher.

If it’s really bad, consider talking to a debt charity. No-one decent will charge you for debt advice: if someone is trying to extract cash from someone with a debt problem, consider them a wrong ‘un and avoid. Step Change and Citizens Advice are good places to start.

Why bother?

This is an important philosophical point. Spread over a long enough period of time, debt can look pretty cheap and may not be making a big dent in your monthly outgoings. However, it’s worth considering that debt matters to your credit rating, affecting your ability to get a mortgage or car loan. If it’s really bad, utility providers or phone companies may not deal with you. Suddenly, life becomes a lot more complicated.

Also, debt means that everything cost more. Who would voluntarily sign up to pay 10-15% extra for everything they buy? Yet that’s exactly what you’re doing if you buy everything on a credit card and then don’t pay it off each month. As an incentive, think what you could do with the extra cash once the debt is paid off. If you’re no longer giving up £200 in debt repayments, it’s like getting a chunky pay rise.

Perhaps most importantly, debt is stressful. It gnaws away. Tackling expensive debt can make a big difference to how you feel as well as your finances.

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