9 tips for dealing with debt

Having too much debt can be stressful. It can also be costly: interest rates rises in the past two years have made debt more expensive for many of us. And this is at a time when prices of goods and services have also gone up.

Against this backdrop, we offer nine tips to help you assess and address your debt levels.

1. Speak with someone you trust

According to analysis from UK charity Debt Justice, 12.8 million UK adults are struggling under a heavy debt burden. This represents a rise of two-thirds on 2017 levels (1).

Identifying the problem is one thing, but trying to assess and address exposure to debt can be challenging for some people. You might, though, find this easier to achieve by discussing a small part of your finances with someone you trust, such as a friend or relative. If that goes well, you could perhaps follow up with a deeper look at your overall financial circumstances.

Alternatively, you could turn to free, publicly-funded services for help and guidance, such as Citizens Advice and MoneyHelper. Both of these organisations have sections on their websites dedicated to dealing with debt.

2. Prioritise your debts

Separating your debts into the three categories shown here can be an important step when it comes to reducing the cost of your outgoings.

Top priority debts

The impact of this category of debt can be serious and stressful. You can find lists of top priority debts on the Citizens Advice and MoneyHelper websites. These debts can include rent and mortgage arrears, secured loans, council tax arrears and utility bills. If you’re unable to pay these, Citizens Advice and MoneyHelper might be able to help you understand your circumstances and develop a repayment plan.

Medium priority debts

The next category of debt includes credit cards, store cards and unsecured loans. These can often be relatively expensive but have more flexibility. If you have no top priority debts, then identify the most expensive and pressing medium priority debts. Focus on paying these off first while maintaining the minimum payments on the others.

Low priority debts

If you have a government-backed student loan or a mortgage and are up to date on your payments, you could consider maintaining minimum payments on those debts. But you could also make larger repayments on higher priority debts. Student loans are often issued on very favourable terms, with low interest rates and repayments only required after you’ve reached a designated level of income.

You could also check to see if you can get a mortgage on a lower rate of interest. But you might want to ensure you won’t be penalised with early repayment charges. You may also want to ensure you are dealing with a reputable mortgage provider who can help find a deal that works for your unique circumstances.

One word of caution to those considering switching lenders: frequently applying for new credit or borrowing in a short space of time could negatively affect your credit rating. A good credit rating can offer significant benefits, including lower rates on mortgages and car loans (2).

3. Clear the most expensive debt first

Let’s suppose you have three credit or store cards. List the interest rate you’re being charged on each, which could, for purposes of illustration, be 25 percent, 20 percent and 15 percent.

The card charging the highest interest rate would usually be the one to clear first, followed by the one charging the second highest rate of interest. If you don’t do it in this order, you could end up paying higher interest charges for longer than you might need to.

For example, while you continue to make the minimum payments on the cheaper two cards, you could make overpayments on the most expensive one. It doesn’t matter if that card has the least or the most amount borrowed on it. It’s costing you the most per pound borrowed and would typically be the one to deal with first.

Once you’ve cleared the most expensive one, move on to the next most expensive. This could create a snowball effect: as the total debt and average interest rate comes down, the money you’re using to pay off your debt should remove bigger proportions of the debt.

4. Consider using savings to pay off debt

It can be tempting to set aside some cash or savings as a nest egg. If you’ve cleared your debt, this could make sense. But if you still have debt, keeping a cash nest egg could cost you money unnecessarily every month.

Here’s an illustrative example:

• Imagine you have £1,000 on credit cards, charging an average interest rate of 20 percent.

• You also have £1,000 in a savings account earning 4 percent a year.

• That means you’re paying at least £200 a year in interest on the one hand while earning £40 a year before tax on the other.

In this illustrative example, the feelgood factor of having a nest egg is costing you £160 a year. And that’s not allowing for tax that could be due on the interest payments or higher interest rates on credit or store cards.

The same principle works if the amount of savings and debt don’t match. So, using £500 in savings could halve your illustrative debt of £1,000 and reduce your illustrative annual debt payment by £100, making it easier to repay the remainder.

But you must take into account whether or not you can withdraw the savings with little or no financial penalty. Depending on how much that would cost, it might make sense to use it to pay off as much medium and top-priority debt as you can as quickly as possible.

Please note that your situation will become more complex if you have long-term investments. In this case your wider personal circumstances should be taken into account, and you may want to take professional financial advice before making a decision. At Schroders Personal Wealth, one of our key principles is to have regular reviews with an adviser, to help ensure your financial arrangements match your unique and changing circumstances.

5. Replace expensive debt with cheaper debt

This can make the whole process of debt clearance considerably more manageable, although it could require some self-discipline.

One way to reduce your expensive debt could be to consolidate your costlier borrowing into a cheaper loan with a reputable bank or building society. Alternatively, you might be able to transfer money from an expensive credit card to a cheaper one. But you may want to check the transfer charges and the time limits on any interest-free offers.

In either case, once you’ve cleared your expensive credit cards, you may want to avoid using them again. It might even make sense to close the accounts completely, to remove the temptation to use them for non-essential purchases. Reducing the number of credit cards and loan facilities you have (even if you’re not using them) also can improve your credit rating.

Even when you’ve cleared all your debt, it can still make sense to keep one low-interest credit card tucked away for rainy day funding.

6. Clear your credit card balances each month

If you do have a credit card, then you may want to clear the debt in full each month, before interest charges are applied. If you’re unable to do this, then you might be spending beyond your means and it could be time to make a budget and retake control of your finances.

7. Prepare for the unexpected

If you are debt-free, it could make sense to keep a limited amount of cash for a rainy day, perhaps to cover three to six months of expenses. But the real value of cash can often be eroded by inflation, so there are risks in holding too much cash.

8. Make a budget

This doesn’t have to be complicated and MoneyHelper offers a ready-made online budget planner. A budget can reveal some home truths about your finances and enable you to control your money rather than the other way around.

A simple example might be that you’re buying two coffees each weekday from one of the well-known coffee chains. That could add up to around £119 a calendar month (at £2.75 per coffee). Making your own coffee means you still get the drink without the high expense and could help you hit your budget targets.

9. Create a financial plan

Once you have a budget you can start to plan. In our view, there are four key steps to creating a financial plan:

• Create a timeline

• Understand where you are today

• Plan how to get to where you want to be

• Review your progress.

Creating a financial plan can help you achieve your life goals and improve the quality of your life, and not simply improve your finances. And that’s a real incentive to bring any debts under control.

Sources

1. Debt Justice (debtjustice.org.uk), ‘12.8 million UK adults weighed down by debt’, 2 July 2023.

2. Experian (www.experian.co.uk), ‘Improving your credit score’, 18 January 2024; and ‘6 reasons why you want a good credit score’, 21 July 2023.