Misc

How I'm reducing my debt

I recently came across some notes I’d made some years ago about how I planned to reduce my debt and increase my savings. It is something that has worked (and is working) for me and it might be useful to others so I thought I’d share it. This comes with the caveat that you need to look at your own personal situation and apply this only if you are comfortable with it.

Reducing Credit Card debts

If you do not have the option of replacing high interest credit cards with a lower interest loan there are some things you can do with your existing cards.

If you have multiple cards, pay off the card with the highest interest payments first.

Say you have three cards each wanting a minimum payment of £50 each. The interest rate on each card is different and you have a budget of £200 for repaying credit cards. The card with the highest interest rate is costing you more than the others. Pay £100 per month to that and leave the others paying the minimum.

Assuming you are not still spending on the cards the two cards you have left on minimum payments only will also start to slowly reduce meaning their minimum payments also go down. This means more money for paying off the expensive card so its debt reduces more quickly thus getting rid of the expensive debt. Once that card is paid off choose the next most expensive card and repeat the process.

I once worked out that if I just left all my cards on the minimum payment only it would take 27 years to pay off the debt I had and cost three times the the original debt.

Increasing Savings

Extended warrantees and consumer insurance

Some time ago it occurred to me that I’ve rarely needed to use extended warrantees that shops offer on consumer goods. The same goes with mobile phone and laptop insurance. In fact in the last decade I’ve had one mobile stolen and one microwave break in what would have been the extended period. The total cost of that was £250. However, compare that to the cost of the insurances and extended warrantees that I was offered for the same period.

What I did instead was set up a savings account that I’d put money into every time I was offered an extended warrantee or a (in my opinion) pointless insurance policy. The last time I was offered mobile phone insurance they wanted £5 per month. So £5 per month goes into that account. PC world wanted £15 per month for insuring my laptop with some “support” services I didn’t need*, so that goes in too.

Incidentally, I have my laptop (among other specified items) covered on my home contents insurance and it costs me an extra £50 per year, so that (£4 per month) gets deducted from the money PC world wanted. So I now have £16 per month going into a savings account just from those two things. If either my laptop or mobile needs to be unexpectedly replaced I have some funds to draw on. In the case of the laptop I’d be able to put the funds back when my home contents policy paid out too.

Be careful what you consider to be a pointless insurance policy. I would never class home contents or buildings insurance as pointless even although I’ve paid thousands of pounds over the years into such things and only received back about £200 so far. The simple reason is that I don’t have nearly £200K to replace my home, nor do I have the resources to suddenly replace large quantities of my belongings either if the need arises.

Also, some people I’ve spoken to do seem to regularly have accidents with their laptops or mobiles so the dedicated insurance policy may be good for them.

Over the years I’ve built up a savings account with about £3000 in it.

* I almost walked out the shop, I tried to explain I was a software developer and all the issues he was telling me the support would cover me for I could deal with perfectly capably on my own.

Paying things monthly

Some things like insurance policies can be paid monthly instead of annually. At first this may seem an excellent way of spreading the cost, but beware that the insurance company will often charge quite a hefty interest rate for that. If you can pay up front you can save quite a bit of money.

When I first started doing this I couldn’t afford to pay all the things I wanted upfront, so I had to take the hit of the interest payments the first few years. What I did instead was set up another savings account to save up for each item so that when the renewal date came around I had enough money to pay it up front the next year.

As I couldn’t afford to start doing this for everything I chose one thing that I could afford to pay twice over (once to the insurance company AND the same amount into the savings account). At the start of the next year I could afford to pay that insurance policy up front, for much less than it had cost the previous year, so I had money left over in the savings account too. I then moved on to starting to pay the second policy twice over (once to the insurance company and once into my savings account).

Over time, I also added car tax (an annual payment if you want it cheap), an estimate of the servicing charges for my car (MOT, servicing costs, tyre replacement costs*, etc) and so on. I worked out what those costs are on a monthly basis and add it to the savings account. When my car tax is due the money is already there.

Other things which I buy on a longer cycle (a new PC, a new car**, etc.) I do the same thing with. It all starts to add up, and I much prefer having the money in my account than in someone else’s account.

* If you are curious, I actually calculated that based on my driving style I need to replace a tyre on average once every 6500 miles. Knowing that and my average annual mileage I can annualise the cost.

** Although with the amount going in to my savings account for a new car, I’ll be two or three cars down the line before I can walk into the showroom with all the money up front.

Offset Mortgages

In my opinion these are one of the best inventions in the mortgage market. There were a lot of really duff ideas in that area over the last few years like endowment mortgages and sub-prime mortgages, but offset mortgages are one of the ideas that really works well, I think.

How they work is that they money in your savings account offsets the capital that is to be repaid on your mortgage. What that means is that, say you have a £100K mortgage and £10K in your savings account you pay interest on only £90K of the mortgage. Since mortgage interest is typically* higher than a savings rate you might be offered on a savings account the saving in interest on the mortgage is better than the interest you would have received on the savings account. Added to that is the bonus that since you are not receiving any interest payments on the savings the tax is zero, so it works out even better.

Depending on the mortgage lender there are a variety of ways to calculate how the offset works. My particular lender gives me three options and I can change those whenever I want.

1. Offsetting reduces the interest payments you pay each month. The term of the mortgage remains the same as the capital is being repaid at the same rate, however the monthly mortgage payments are reduced.

2. Offsetting increases the capital repayments each month. Instead of reducing the monthly bill, it stays the same as if there was no offsetting, the savings you would have made are used to pay off some more of the capital. Your capital reduces faster which means each month you are paying off more capital than you would have been otherwise. The term of your mortgage reduces as the capital is paid off more quickly.

3. A hybrid of the above two options. Essentially option 2 is in effect until the interest rate changes. The mortgage is then recalculated to maintain the original end date, the overall monthly bill will reduce at this point if you had something to offset.

When I did my calculations I estimated that over the course of my mortgage I’d be £15K better off than a regular tracker mortgage + a high interest savings account.

* Although I have seen a number of savings accounts these days with interest rates at 4% above the Bank of England base rate, so it may be that right now one of those savings accounts may be the better option.

Other things

Other things I did to cut my debt and increase my savings were mostly to do with cutting out the subscriptions to things I didn’t need, or reduce my outgoings in other ways.

For example, I worked out that I was only really watching Sky for one show. It was much cheaper just to buy the DVDs. So that’s what I did. And I can watch my favourite TV show any time I like now.

I was buying a weekly rail pass, so I changed to a monthly pass. And if I planned my holidays far enough in advance I could match them up with the renewal date of the pass, or go back to weekly passes briefly, so that I wasn’t wasting additional money.

Also, I didn’t need to go and buy a sandwich at lunch time. I could just bring a packed lunch. Although I have to admit that didn’t last long as I’m not a morning person and making my lunch the evening before just meant it wasn’t very nice when I came to actually eating it.

Shop around for deals. If you have gas and electricity there are often deals where you get money off if you go with the same supplier.

Do you desperately need that new TV or will the old bulky CRT behemoth you have still do? Seriously! My parents have a really nice HD TV and quite frankly I can’t see the difference unless I’m really close up staring directly into the pixels.

Finally

I’d like to say that these are things that have worked for me.I present them as mere options. Whether they will work for you depend on your circumstances. I’m not a debt councillor nor do I want to be. You take this advice at your own risk.

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