John Lowe – The Money Doctor gives you some advice in managing your finances in this weeks Sunday Business Post
The easy way to fix your finances
23 January 2011 By John Lowe
Debt management is not just a simple matter of setting aside a certain sum each month to meet the mortgage, loan and other fixed repayments. It requires planning, prudence and a degree of discipline which many of us may have lost sight of during the boom years.
What is debt?
Debt comes in many shapes and forms, but can be divided into three simple categories.
1. Long-term debt: this mainly consists of mortgages, but can also include any other debt that you have held for longer than seven years.
2. Short-term debt: borrowings Which would run for less than seven years and can include borrowings for car purchase, furniture, holidays, educational or other family purposes. Increasingly, this also includes conversion of hard-core overdrafts and credit card borrowings.
3. Running or current debt: typically, this would include bills which have to be settled every two or three months.
These include utilities such as electricity, gas, telephone/broadband, etc. Credit cards used for day-to-day expenditure would also be included here.
The crash of 2007/2008 has meant that most people who have been fortunate enough to hang on to their jobs have suffered sizeable reductions in real income, through a combination of pay cuts and income levies.
Add to this the interest rate increases for all but holders of tracker mortgages and the pressures on borrowers are all too obvious. Here are the key steps you need to take in tackling your debt.
Where are you now in your financial life and where do you intend to be at the end of this year? In five years? More importantly, where are you now in relation to 12 months ago and what steps have you taken to prevent any further drift ?
As I said, debt management is more than meeting your loan repayments as they arise. It should be an active rather than a passive exercise and should form part of a strategy of constant review. If you are in control of your finances now, it’s important to stay in control.
Where to start
1. Look at your family’s n et monthly income.
While you may Not be able to increase your gross earnings, it is important to ensure that you avail of all the tax allowances and credits et al.
For instance, have you claimed your medical expenses, dental costs, bin charges, your rent relief or pension relief for the last few years?
Social welfare and child benefit payments, additional jobs and any other forms of income should all be included in your net monthly income.
2. Now, consider your expenditure.
Many of us have no clear idea of our spending on such things as groceries, travel, entertainment or clothing. On the other hand, we know only too well how much we spend on utilities, heating, insurance, etc.
Keep a record of all your spending over a two or three week period – use a diary or a notepad – and involve your partner and family so that a full picture of family expenditure can be determined.
The initial shock of how much you spend on casual unwanted items will wear off. That bar of chocolate you munch every time you fill your car with petrol, the magazine you don’t have time to read – the list goes on.
3. Go through your bank statements over a three-month period, and have a look at al l standing orders and direct debits.
Are you still continuing to pay club subscriptions or making donations to charities which you no longer wish to continue? Consider each and every financial commitment: are they all necessary?
Remember the Money Doctor mantra: stop spending and, if you must, ensure best value.
Your expenditure can be broken into three categories, the ABC of expenditure:
A. Fixed outgoings: they consist of such things as mortgage/rent, loan repayments, electricity, gas, telephone costs, transport, educational, food and essential clothing, insurance, etc.
B. Discretionary spending: these cover all non-essentials such as entertainment, holidays, sporting and leisure activities.
C. Savings: these would include the provision of a rainy day fund – remember the ideal is to have three to six months annual income in an accessible account pension contributions, educational plans or other sums set aside to meet future expenditure for you, your partner and/or family.
By now, you should have mapped out your spending on a monthly or weekly basis.
You should then look at your fixed outgoings to see if there are cheaper alternatives. Electricity, gas, telephone/broadband and cable television are items that should immediately come to mind, but there could also be substantial savings to be achieved by shopping around for cheaper car and household insurance, and reviewing your life and health insurance.
Also, interest rates both for loan and savings products constantly change. What might have been the highest rate for your savings last year could very well be the lowest this year.
Now, have a look at your net monthly income and see how it matches up to your outgoings. All of these steps may achieve some savings, but essentially they merely consist of a tidying-up of your finances. This is something you should do every year, in good times or bad.
That is why you need to spend about two hours every month on your finances. By now, you will know your position and whether meeting your monthly commitments is causing, or is likely to cause you, problems.
Examine your Options
Your mortgage repayments are likely to be your biggest commitment but, in terms of interest rate, they are also the cheapest. If you are fortunate enough to have a tracker mortgage (tracked to the European Central Bank rate, now 1 per cent), do not be tempted to switch to any other product.
Trackers are like gold dust, and lenders are using all sorts of means to switch you from them.
Looking for an extension to your interest-only facility only gives them leverage to discuss that switch. Pay the full capital and interest repayment if needs must.
If, however, you are on a standard variable rate mortgage, some of these vary from lender to lender.
Check where your rate is compared to others on the market. If it is on the high side, you should first of all consider taking out a fixed rate with your existing lender.
Variable rates are set to continue to rise, even though the ECB rate will probably stay at its present level until late 2011. If you are not offered an attractive rate, you could shop around if you qualify.
You will be well placed to switch lenders if:
* your loan is less than 80 per cent of your home value
* you have sufficient earning to justify such a switch (as a rule of thumb about 4.5 times your annual income for both applicants)
* most lenders will approve a mortgage up to age 65, with a few up to age 70 and this has to be borne in mind if switching
* you have a good credit history, with no missed payments or judgments.
You may also have car loans, furniture or home improvement loans or overdrafts.
The ‘‘sniper approach’’ to getting out of debt should be adopted. This is where you ‘‘pick off’’ the most expensive debt first if you can. Some of these personal loans can attract interest rates over 16 per cent.
The greater the risk, the higher the interest rate.
These are bank mechanisms for giving You money upfront – ie, a loan – on the promise of an eventual lodgment to the account to regularise the account, but charging you through the nose for it. They can also be misleading and lure you into a false sense of security.
Firstly, they are hugely expensive – personal overdraft interest rates start at around 13 per cent. Secondly the set-up charges, referral fees, unpaid fees, surcharges (an additional amount of interest – could be 1 per cent per month – chargeable if you exceed the overdraft limit without permission) are simply not worth it.
Managing without an overdraft is the ideal. Remember also the requirement for overdrafts is that they must be in credit for 30 days each year.
So you’ve ‘maxed out’ your credit card or cards, where you have used the full credit limits in your cards. What are your options? Paying 3 per cent of the balance each month will effectively create a 20-year loan for you based on the high credit card interest rates.
If your credit rating is good enough, however, and you are still in satisfactory employment, you could switch to one of the seven credit cards that offer 0 per cent on transferring your balance over to them for a period of time.
If you have an asset that you can dispose of in order to reduce your borrowings – such as a holiday home you rarely use, or even a second family car – be prepared to swallow your pride and take the hard decision. If you are sitting on any substantial level of savings, it would make sense to use some of them to payoff your most expensive borrowings, particularly credit cards or personal loans.
Also, if you are making monthly payments to a savings plan and you have sufficient rainy day funds, you should consider suspending the plan for a period and diverting the payment in reduction of your debts.
If none of these is an option you can avail of, then you could consider consolidating all your non-mortgage borrowings either on the security of an asset, eg, your home or, if allowable, in one unsecured personal loan and you can show the ability to repay. Credit unions are still obliging thousands of customers once they have been able to prove repayment capacity.
If your mortgage is sufficiently low, and you have good equity in your home, you may be able to convince your mortgage lender to let you top up the mortgage over its remaining term.
However, such loans are getting more difficult to obtain, with some of the bank lenders only accepting their own personal loans for limited consolidation.
The greatest priority for most of us must be to retain the family home. Therefore, maintaining mortgage repayments, no matter how small, has to be a must.
Other lenders can take various legal steps against you and impair your credit rating by registering missed repayments with the Irish Credit Bureau, but your mortgage lender is the only one who can repossess your home.
They have a legal charge against it.
If the warning signs are there in terms of an ever-increasing overdraft or a credit card on which you make the minimum payment each month, now is the time to take action.
Don’t wait until you’ve missed payments and the letters start to arrive. Ignoring communications helps no one, neither you nor the creditor.
With mortgages, all the lenders have an agreement with the government in terms of how to deal with mortgage arrears and the various time limitations of pursuing legal action, but this only applies where the mortgage holder is already engaged with the lender in relation to those arrears and is actively communicating.
Your mortgage lender will already have a dedicated section dealing solely with borrowers in arrears.
Taking early action can head off impending trouble, and will also impress upon the lender that you are determined to work your way through any problems.
Define your Endgame
Decide what you want to achieve, but also be realistic enough to know what is achievable.
Look at the trend in your finances over the last two years, and determine if your situation is temporary or likely to last for a number of years.
Have you any source of additional income coming available in the next few years, such as an inheritance, a maturing investment plan or endowment policy or anything of this nature?
Will any of your dependants become self-financing?
Will your partner be able to enter the workforce if unable to do so at the moment?
Will you yourself be able to develop any sources of additional income? Reinvention is fast becoming a buzzword in business circles.
In other words, if you are preparing to approach any of your lenders/ creditors to negotiate with them, be sure you can show them that, as far as possible, you have a plan that is realistic and achievable. Part of this approach will be cash flows, budgets and any potential dreams and plans for the future that will repay their debts.
First things first
Look at any short-term borrowings where the repayments are large relative to the size of the loan. If you can manage to extend the terms of these loans without attracting a higher interest rate or any punitive penalties, negotiate these first.
If you then decide to renegotiate your mortgage, it’s likely that the lender will give you their own version of an income and expenditure worksheet which you can complete from the budget template you’ve already prepared.
Current account statements, all loan statements, insurance policies, savings accounts and investments including pension contributions will all be required by your lender.
Going to the initial requested meeting armed with all these facts and figures will show your lender how serious you are.
What to expect
Your creditor/lender will by now have developed a good level of expertise in handling these situations, and will have a suite of tailored solutions to cover most scenarios.
The most likely financial solutions they will offer are:
* for mortgages, extending the term
* interest-only payments for six months, one or two years
* a moratorium on all repayments – capital and interest – for a number of months
* a top-up mortgage/loan to allow you to consolidate all your other loans.
The first option of extending the loan term ould be attracctive if it alleviates the problem – ie, eases the cashflow and allows capital and interest payments to be continued.
Bear in mind that, if you are on a tracker mortgage interest rate, extending your loan may terminate your original loan contract and you may be forced to accept a standard variable or fixed interest rate.Your lender will always send you full details of any switch agreed.
You will need to carefully read the same. Interest-only for a period will obviously help, as in many cases it can effectively halve your monthly payments.
The saying that you can’t make a silk purse out of a sow’s ear rings true: if you haven’t got it, you can’t give it. So lenders are forced to at least grant interest-only extensions for a set time. Obviously, this cannot go on forever, but there is little choice for the lender while the property market continues to weaken and sales are flat.
Some of the lenders will not give further interest-only extensions on home loans, but will approve payment reductions – this is tantamount to the same thing.
The third option, of a moratorium on all payments, is purely a very short-term solution and, unless your problem is also short-term – eg, due an inheritance – it will not really be of any assistance to you.
The final option of the top-up, if available, would be the optimum solution where additional funds are approved to consolidate other debts, possibly give you some upfront cash and some breathing space. In the present climate, this is probably the least likely, as all lenders have liquidity problems and have enough impairments without potentially taking on more.
In the absence of a top-up, a combination of the first two would be most beneficial to you, as it would extend the term of the loan and also give you the breathing space of interestonly payments for the initial period.
Give a little
In any negotiation case, there is give and take.
Your lenders will expect sacrifices to be made if you are looking to extend facilities with them. Just as with a new enterprise, prudent bankers like to see entrepreneurs invest their own money into a project before agreeing loan facilities; so too the debtor. To sum up, if you have debt issues, these are the steps you have to take.
1. Communicate: do not ignore creditors’ letters or calls. Burying your head in the sand will only prolong the agony.
2. Check your income: are there any other channels of income? If your employment has gone or your business ceased, have you reinvented yourself?
With financial commitments, they have to be serviced and income therefore has to earned. Dust off your CV, prepare that new business plan and create income. Jobseeker’s allowance or benefit should only be temporary.
3. Check your expenditure: do the analysis of your spending and prepare a full budget that you may need to show your creditors.
Show clearly where you have made cuts and sacrifices. If you haven’t got it, you shouldn’t spend it.
4. Give hope: if you have lost your job or ceased your business, you must have a plan that will at some stage recreate an income stream and recommence loan payments or fully pay off the debt. Declare your intention and put a time limit on the recovery yourself.
5. Pay something: even if your lender does not agree with your proposals, choosing to ignore demands or to pay nothing at all will only escalate repossession or worse, prison. If your interestonly extension request is refused by your lender, for example, you could cancel the lender’s direct debit and manually pay the interest each month on time.
By making these payments, you stand a far better chance of leniency should the lender take you to court.
Finally, take professional advice. I cite the example of golf professionals: they still use coaches.