Getting Out of DebtSee also: Long-Term Financial Planning
It is astonishingly easy to get into debt, and considerably harder to get out of it again. Credit is available in a huge number of different ways nowadays, from mortgages and credit cards, through to payday loans, ‘buy now pay later’ arrangements with retailers, or simply borrowing from family and friends. This makes it easy to borrow money without a clear idea of how you are going to pay it back.
Many people also end up in debt simply because their expenditure exceeds their income. This makes it hard to pay your bills, rent or mortgage on time, and in turn means that you may incur further debts in penalties for late payments.
This page discusses what to do if you are in debt, and particularly how to get out of debt as fast as possible.
Understanding Your Debt
The first step towards getting out of debt is to understand your precise situation.
You need to know exactly how much you owe, and to whom—and also the consequences of not paying immediately.
It is therefore a good idea to make a list of precisely what you owe. This should include:
The total amount that you owe for long-term loans like mortgages or student debt;
The total amount of any one-off unpaid bills for utilities or household repairs;
The total amount of discretionary bills like credit cards, which are best paid off quickly, but can be serviced in the meantime; and
The amount that you need to pay each month under long-term loan repayment agreements, such as your mortgage or rent, or student debt.
Check whether you have fallen behind on any of your payments on all these items.
Repayment or interest?
It is important not to make the mistake of thinking that it is enough to pay the interest on a short-term loan or credit card each month.
This is NOT enough. If all you pay is the interest, the loan will never get any smaller.
Your monthly payments MUST include enough to pay off the loan within a reasonable period (ideally before any further interest is accrued).
This process of listing your debts will give you a much better understanding of your overall situation. In particular, you will be clear about how much money you need each month to meet the required repayments or payments on long-term loans. You will also understand the extent of your short-term debt and whether you have fallen behind on any payments. You can then see whether you can afford to meet your monthly payments.
The important aspect of this step is that it tells you whether you have a problem.
You should now understand whether you can manage your debt, even if it takes a long time to pay off your debts. If you can afford to pay all the required monthly (re)payments each month, and still meet all your other expenses, then you can stop reading now.
However, you may well find that your monthly income does not cover your outgoings. This means that not only will you NOT be able to pay your debts back, but they are likely to be growing each month.
In this case, it is a good idea to create a monthly budget (and there is more about this in our page on Budgeting). You may also find it helpful to read our pages on Making More Money and Reducing Your Outgoings, as some of these actions may be sufficient to stave off the problem.
Getting Help and Benefits
If your household income feels very squeezed, and you are starting to go into debt, it may be worth investigating government benefits and other grants. These are often available to help people avoid debt, so are worth considering early. A small addition to your income could make all the difference.
Prioritising Your Debt
The next step is to prioritise your debt. This is important because the consequences of not paying some loans can be much more serious.
There are three levels of priority:
A debt emergency is where you are facing something that needs immediate action.
You may, for example, have been visited by bailiffs, or be threatened with disconnection of one of your utilities, or even eviction from your home.
Priority debts carry the most serious consequences if you don’t pay them.
This does not mean that they are the largest debts. Even a small debt of the wrong kind can be a problem. Priority debts include court fines, payments to other government bodies such as income tax, council tax or TV licence, child maintenance costs, utility bills, and mortgage or rent payments. Not paying these can result in larger fines, being sent to prison, disconnection of services, or eviction from your home. You may even be made bankrupt.
Non-priority debts have less serious consequences for non-payment
They include debts where your creditor could take you to court, or call in bailiffs—but you probably won’t end up in prison or losing your home. They include credit card bills, overdrafts, personal loans, and money borrowed from friends or family members.
If you are facing a debt emergency, it is a very good idea to get in touch with a debt adviser. This is also a good idea if you are struggling to pay off debts, and are not sure how to manage.
In the UK, some debt advisers are funded by the government, and provide free, independent advice on how to manage debt. You can find more information at Moneyhelper.
Paying Off Debts
If you have some spare cash to pay off your debts, you are expected to treat your creditors fairly in terms of paying off debts.
Paying off priority debt first is fine, but if you have more than one priority debt, it is worth talking to a debt adviser before making any arrangements with any creditors.
WARNING! Don’t ignore your non-priority debts while you pay off your priority debts.
Instead, get in touch with your other creditors. Explain that you are trying to sort out your debts, and ask them for breathing space. In the UK, a debt adviser can apply for you to join the Debt Respite Scheme. This gives you 60 days during which your creditors cannot contact you for repayments, and interest on debts should be frozen. This will give you enough time to make a plan for repayment.
There may be several different arrangements that you can make to pay off your debts. Some of these are more formal than others.
The best option will depend on your situation.
First, your audit of your debts may have shown that you don’t have a big problem, but you owe more money that you would like, or your monthly repayments are a bit too high. In this case, your first step is to talk to your creditors and/or your bank. It may be possible to take a few simple actions such as reducing your monthly payments for a defined period, or consolidating all your loans into one with your bank, possibly with a lower rate of interest. This could make it possible to meet the required monthly repayments.
Other options include moving to a new credit card that charges no interest on balance transfers for the first 12 months. This gives you a year to pay off your credit card debt. However, you need to be disciplined, and NOT put anything on that card AT ALL for the full year.
You may also be able to take a repayment ‘holiday’ from some loans without incurring too much additional interest. For example, mortgages often offer this option. This will allow you to pay off other debts faster, including those with a higher rate of interest such as credit card debt. However, be aware that your lender will continue to charge you interest during your repayment holiday, and it will therefore take longer to pay off your debt overall. This option should therefore be carefully costed before you start.
There are also some more formal options for dealing with more serious debt problems. For example, in the UK you can:
Set up a Debt Management Plan with a dedicated provider. You then make a single monthly payment to the Debt Management Plan provider, and they pay your creditors. This is only really possible if you have non-priority debts, but it can be a good way to manage your payments each month. Be aware that you will have to pay a management fee to the provider.
Set up what is known as an Individual Voluntary Agreement, where you agree what you will pay back each month. You will need at least £70 per month to set up this agreement. The agreement lasts a set amount of time, usually five or six years, and anything that you have not been able to pay by the end is written off.
Offer a full or final settlement. If you have a lump sum of money that would cover part of your debts, but your income is squeezed, you might offer the lump sum to your creditors in final settlement. This means that they agree to accept the lump sum and write off the rest of the debt.
Getting Your Debts Written Off
What about if you do not have any spare money, and you can’t see any way to pay off your debts, even over time?
Again, there are likely to be some alternatives available to you.
In the UK, you may be able to get a Debt Relief Order if you are on a very low income and have few or no assets. This freezes your debt for a year, then writes it off if your circumstances have not changed. These orders can only be obtained if your debt is less than £30,000, and your total assets are worth less than £2,000.
You may be able to get your debts written off, especially if your circumstances have worsened abruptly, and there is no chance of them improving. You need to have no available income, assets or savings for this to apply.
As a last resort, you may decide to apply for bankruptcy. This writes off all debts that are included in the bankruptcy order, but requires you to sell your assets to fund as many debts as possible. However, some debts cannot be included. In the UK, these include student loans and child maintenance payments.
It is NOT your decision about whether you are declared bankrupt. You can only apply. In the UK, the decision is made by the government’s Insolvency Service.
WARNING! Bankruptcy has serious consequences and should not be considered lightly
There are huge potential consequences to being declared bankrupt. For example, if you own your home, you may be forced to sell it because all your assets can be taken into account and used to pay your debts.
You will not be able to apply for credit of more than a certain amount until your bankruptcy order is discharged.
You may find it extremely hard to obtain credit in the future. Bankruptcy affects your credit rating, and banks can keep the information on file for up to six years.
A Final Thought
Being in debt is often very frightening. However, it is better to face up to the situation and start to take action to address it, than to keep worrying.
As a first step, it is often a very good idea to speak to someone who can provide independent advice, such as a debt adviser. A problem shared often feels like a problem halved, and money problems are no exception.