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Debt Management

Debt management is fundamental in personal finance. In the UK, household debt is a serious issue that needs to be considered. People take out loans and credit card bills to go on holidays, buy new cars, clothes, and other superfluous things that they could most likely live without.

With unsecured debt – which is debt that does not have collateral or a guarantor, such as credit card debt – having reached a new peak in 2019 at a record £15,400, the Guardian noted, individuals must start to proceed with caution in order to not go bankrupt. I could not find more recent statistics – but it all points to an increase in debt due to COVID-19.

In the Office for National Statistics, a report showcases that in the period from April 2016 to March 2018, household debt amounted to £1.28 trillion – which is a large chunk of the GDP.

Furthermore, a January 2020 survey has demonstrated how over half of UK adults could be heading into 2020 with personal debts of up to £100,000.

Due to this reason, it would be important for you to know how to appropriately and effectively manage your personal debts, and there are many ways to do this. First, let us understand exactly what debt is and the different types of debt that exist.

Debt is when a person borrows money or assets from another. Typically, lenders (the person lending you the money/asset) will charge an interest, as this is how they earn money – otherwise why would they lend? Commercial banks, credit agencies, and other financial institutions are the primary lenders in the UK. If you do not have the money to buy something, and wish to, perhaps establishing an alternative source of income – maybe passive income – could be the best way to do so. I cover passive income in today’s premium article, so why not subscribe to our Premium Membership to gain access to it? Only £5 every month!

Besides unsecured debts, there are also secured debts. These debts have a collateral, such as a house – usually mortgages. If you fail to pay these debts, they can take the house from you – or whichever asset you have used as collateral. Sometimes, business shares can also be used as collateral – although this can pose a larger risk to the bank if the shares become negligible in value.

However, secured and unsecured debts is only one way of classifying debt. Another way would be to class it as “good” or “bad”. The main difference is that “good” debt will help boost your net worth and has prospects of paying for itself, such as student loans (refer to our previous article for why education is so important), mortgages and investments in your own business.

Otherwise, “bad” debts have no prospect of paying themselves and are simply a drain of your wealth. This can include credit card debt for paying for things that you cannot afford, such as expensive clothes or living beyond your means. In the long-run, you will accumulate too much debt and potentially enter into bankruptcy.

Bankruptcy serves to write-off debts if you cannot afford to repay them. This is a last-case scenario which has certain advantages. After becoming bankrupt, you are no longer required to pay your debts after 1 year, nor will creditors be allowed to contact you further about repayments.

You can apply to become bankrupt yourself, or your creditor might take you to court and force you to become bankrupt. However, this can also have lots of disadvantages. For instance, if you become bankrupt it will be much harder for you to get access to new credit for a period of 6 years, as your score will be deeply affected. Moreover, you might have to sell your car or home if you become bankrupt. This really should be seen as a last case scenario, and there are plenty of alternatives that could help you better manage your debts.

One of them is a debt relief order (DRO). This method is a bit less severe than bankruptcy, and less costly too. It is only possible if you have debts under £20,000 and if you do not own a home. Unfortunately, it also negatively impacts your credit score; but at least you will not have to show up in court or pay off any debts after 12 months.

Another option is an individual voluntary arrangement (IVA). Whilst the other two you do not have to pay your debt back; in an IVA you pay it back part of it. This usually occurs if you have the ability to pay some of the debt back but not all of it. An IVA requires a specialist person to execute the deal for you, called an Insolvency Practitioner, which is usually quite costly – although this cost will be spread over the typical 5-6 years monthly payments of your IVA.

The IVA might also require you remortgage your home, and/or sell off your car/other expensive items you might own to help pay for the arrangement. Furthermore, it also impacts your credit rating.

As such, all debt management arrangements must be looked after with attention – as they will have serious impacts in your finances. Due to bad debt, you might find yourself in a position where you cannot borrow money for things that might be fundamental in life, such as loans to help your child through education, or a mortgage to have a house to live in.

From the start, you should have a robust mentality towards your finances, so maybe the best way to avoid getting into a position where you require debt management would be by changing your mentality. You should try and value experiences, not possessions. No matter how much you own, how much you have, in the end you will leave it all behind just like everybody else.

I will leave with a few tips:

Refrain yourself from watching too much reality TV and engaging in social media. There is too much toxicity nowadays within it, and it will only hurt you further.

Practice thankfulness. Be grateful for what you own, what you have, there is so many people out there with less than us, less fortunate. Every person has their own challenges. This does not make yours less or more than other people’s, but being too focused on what is going wrong rather than what is going well for you can cause a deep frustration within you that might lead to a superficial and materialistic view of the world.

Organise your spending, through budgets and lists. Having structure will allow you to spend less and focus less on the material things.

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