How to deal with debt and manage your personal finances

Important: This article was originally written by Finimize. Any opinions offered are those of Finimize and not of CMC Invest. 

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Why debt matters

It’s the offer dreams are made of: £1,000 instant cash, sign up here! But take a closer look at the T&Cs and you’ll see those dreaded words: “1,300% APR”. You never get money for nothing, sadly: there’s no such thing as a free lunch, and the cash will cost you by way of debt. Debt can be useful, although it’s also one of the easiest ways to fall into financial trouble. But fear not – in this article, we’ll teach you how to conquer any debt mountain.

What is debt? Debt is simply when you owe money. If you borrowed £10 from your friend last night for McDonald’s, you’re technically in debt to them. But in this article, we’ll be mostly talking about money owed to institutions. That could be an overdraft at the bank (when you go into a negative account balance), an unpaid credit card bill, or a mortgage on your home.

A mortgage is an example of where debt’s not just useful, but essential – most people would never be able to afford a house without a loan. And professional investors love debt: it lets them buy more things with less money up front, so they can rack up a bigger portfolio and (hopefully) bigger gains. But if used irresponsibly, debt can be devastating.

How? When you take out a loan, you have to pay interest for the privilege. That interest is a percentage of the loan, and is normally quoted annually. A 1,300% APR (annual percentage rate) on a £1,000 loan means that you’ll have to pay a whopping £13,000 in interest each year – as well as eventually paying back the original £1,000 you borrowed. If you let your debts accumulate, it’s easy for payments to quickly become overwhelming.

Why does debt matter? Banks aren’t charities, and they won’t be happy if you don’t repay your debts. The consequences of missing payments can be very severe. If you don’t pay your mortgage, your home could be forcibly repossessed by the lender – leaving you out on the street. And even “unsecured” debt like credit card bills or overdrafts could land you in a courtroom, with bailiffs seizing your stuff to pay off the loan. Say bye-bye to your iPhone…

There are long-term consequences too. Big debts can hurt your credit score, making it harder for you to get credit again – including taking out a mortgage or getting approved to rent an apartment. And if things get really bad and you have to declare bankruptcy, that can prevent you from getting certain jobs.

But keep calm and don’t panic. In this article, we’ll show you how to avoid getting into a debt dilemma – and if you’re already in one, we’ll show you how to tackle it. You’ve taken the most important step by looking for help and information – knowledge is the ultimate debt-busting power.

Borrowing sensibly

How do I avoid debt trouble? The only way to guarantee yourself freedom from debt is to never get into debt in the first place. That means making sure you’re always spending less than you earn – so you can pay your credit card bills in full each month, keep your bank balance positive, and sleep at night knowing that no one has any claim to your belongings.

That’s not a realistic situation for most of us, though. Big purchases like a car or a home often have to be financed with a loan, and even day-to-day expenses can be hard to meet when an expensive emergency comes up. In those cases, debt might be an inevitability – but there are still some things you can do to make life after loans as stress-free as possible.️

Consider your options. Depending on what you’re trying to finance, you’ll likely have a few different options: for example, you could pay for a car with a credit card or get financing from the car dealer. For smaller sums, your bank might offer an overdraft – while expensive payday loan companies also sing the siren song of emergency cash. Do some research to find all the loan options available to you, then compare them.

The first thing to look at is the interest rate of each loan. In general, lower is better – it means the loan is cheaper. Interest rates vary wildly: while a mortgage or car loan might have an APR of 3.5%, payday loans can run to 1,000% or more. Make sure you’re comparing APRs – sometimes you might see daily or monthly interest quoted instead, which will look like a lower amount but likely work out to be more expensive when annualised. And if you see an interest-free loan, it’ll normally only be so for a limited period – so check what the interest will be once you do have to start paying it back.

If you take out a loan with fixed interest, your payment will be the same each month. But if you have a variable rate loan, your monthly payments will rise when central bank interest rates do. Make sure that you’ll still be able to afford the payments if that does happen. It’s always best to prepare for the worst (and hope for the best – if your loan is variable, your payments should also fall when interest rates do).

You should also look at the term of the loan: how long you’ll be paying it back for. In general, shorter is better because you’ll pay less in interest. But make sure you choose something affordable – a loan with a longer term will likely have smaller monthly payments, so it may make the most sense even if it does cost more in the long run.

Don’t get swindled by a seemingly great deal; always take care to read the small print carefully in case there are any nasty fees. Lenders can charge a tonne for late payments, early repayments (you may be penalised if you pay off the loan before the end of its term), and all sorts of administrative costs. Investigate all these fees for every loan you’re considering – they’ll likely vary quite a bit – so you can evaluate the true price of each.

Once you’ve figured out the best loan available to you and how much it will cost, plan how you’re going to repay it before you apply. If you can set up a payment schedule in advance, and budget carefully and stick to it, hopefully you can be rid of the debt in the not-too-distant future.

This advice might have come too late – but that’s okay. Next, we’ll look at what to do if you’ve already got a debt mountain of your own.

Debt busting

I’ve got mountains of debt. What do I do? Realising that you need to do something about it is a great first step. Debt is a problem that only gets worse with time: the sooner you start to tackle it, the better.

First, figure out exactly what debts you have. Piles of paperwork can be confusing, and it’s easy to lose track of what you owe and who you owe it to. That can result in missed payments and fees – costing you more – so spending some time making a list of all your debts, when your payments are due, and how much you owe overall is a worthwhile investment.

Once you’ve made a list, you need to prioritise it. Start with things that you absolutely must pay – if missing a mortgage payment could result in your home being repossessed or an unpaid car loan would leave you without transport to work, those should probably be your number-one priority. Similarly, debts that could easily see you in court should be close to the top of the list.

What about non-essential debt? Non-essential debts – like credit cards – go at the bottom of the list. That being said, you should try to at least meet the minimum payment for all your debts each month to prevent things from getting worse.

After the essentials, order the rest of your list of debts by interest rate: you’ll want to prioritise paying the most expensive ones first – and, if you can’t afford to meet all the minimum payments, those with the highest penalties (like late fees). If you want to pay more than the minimum payments (which will get rid of your debt quicker), paying down the most expensive debts first will lower your total monthly payments the fastest.

A good psychological tip is to focus on getting rid of one debt first. For example, if you have a credit card bill, overdraft, and payday loan to pay off, pay the minimums on all three – then put any extra cash you have toward just one: the payday loan (it’ll surely have the highest APR). Hopefully that loan will soon be a distant memory – and you’ll begin to feel like you’re taking back control of your finances.

How do I make these payments? Getting the cash together to pay off your debts is no easy feat, but careful budgeting will help. Figure out your unavoidable expenses – housing, food, travel costs – and consider using a free budgeting app to keep track of them. You’ll then want to think about non-essential spending that you might want to give up, and that which you don’t (if you lose motivation because you’re miserable, you’ll never tackle the debts). If you do have luxuries you can forgo – like eating out or Netflix – then it’s worth ridding yourself of them.

Any extra cash you do have should go to paying off your debt. It’s worth putting this money to one side as soon as your paycheck comes in so you’re not tempted to spend it. And beyond a small emergency fund, don’t even think about saving while you’ve still got debt.

Sometimes careful budgeting might not be enough. But even if you’re on the brink of a debt crisis, there’s still hope – next, we'll look at your options.

What to do in a debt crisis

I can’t make my debt payments – what do I do? First off, see if you can buy yourself some time. If you have credit card debt, you might be able to do a “balance transfer” to a different card with a lower interest rate – many of which also offer 0% fees or 0% interest for a number of months. That’ll prevent things from getting worse for a while, allowing you to get a handle on the situation. Just don’t be tempted to use the new card...

If you’re dealing with multiple loans, you might be able to take out another, lower-interest loan to pay off the originals, which will lower your monthly payments. That’s known as debt consolidation. It means you’re only dealing with one, cheaper lender going forward, potentially saving you hassle and cash – though fees and longer repayment terms for the new loan could see you losing money in the long run, so do your homework.

“Money transfer” cards are another option: credit cards which put cash in your account for a small fee (around 3% of the sum is normal) with no interest charged for as long as two years. If you think you’ll be able to pay off your debts before then, this could save you a lot of money.

What if things are really bad? Seeking advice from a debt counselling charity could be a big help – everyone’s situation is different, and they’ll be able to point you down the best route for you. There are a few things they might suggest. One – “debt management” – involves negotiating with your creditors, moving you to a lower interest rate, and consolidating some of your loans.

If you can’t even afford lower monthly payments, “debt settlement” could be an option. This is where you ask your creditors if they’ll accept a smaller amount than you owe to call the loan quits – kind of a compromise. If they think that lower amount is all they’re going to get from you, they might agree – but don’t count on it.

In the UK, you also have the option of a “debt relief order”: paperwork that legally writes off up to £20,000 of loans if you can’t pay them off (providing that you don’t own your home or £1,000+ of other assets).

What if things are really, really bad? If your debt mountain is truly insurmountable, you still have a self-destruct option: bankruptcy. This is when you legally declare that you can’t repay your debts, they get wiped, and you get a clean slate (well, kind of – you could still owe any unpaid taxes, and student loans are rarely forgiven).

In exchange for a second financial chance, you’ll have to give up a fair chunk of any assets you own (though your car and home might be safe), and your credit score will be decimated. That means you’ll have a really tough time getting insurance, renting an apartment, and getting any form of credit in the future – nobody will want to trust you financially when you’ve borrowed money and not paid it back.

But if you’re backed into a corner with no escape, bankruptcy could be your saviour. And it does have one silver lining: it won’t stay on your credit history forever. Depending on where you live, bankruptcies are usually wiped from credit records after six to 10 years.

So, there you have it: debt, even if it’s really grim, can be overcome. And now you have the knowledge to go out and stop small problems snowballing into bigger ones. Good luck – and spend wisely…

In this article, you’ve learned:

🔹 Debt is when you owe money to someone – and you have to pay them back

🔹 If you do need to take out debt, do your research to find the best option available – and plan how to repay it in advance

🔹 To deal with your debts, prioritise them by necessity and cost

🔹 Balance transfers and consolidation can help you in a debt crisis – and if things are really bad, a debt counselling charity might advise you to settle your debts or declare bankruptcy