Very few people go through life without incurring debt. Most good financial planning at some point will involve the purchase of a house, and only a very lucky minority will be able to do so without taking out a mortgage. On the other hand, many debts are either unnecessary, or inefficient, or both.
Handling mortgage debt
Mortgage debt tends to be a relatively efficient form of debt for several reasons:
- Mortgage interest rates tend to be lower than for almost any other form of debt.
- Everyone needs a place to live: someone who is not paying mortgage interest will probably be paying rent.
- Mortgage debt is secured on the value of the relevant property.
Mortgage payments must be kept up. However overpayment of a mortgage (i.e. trying to pay off the mortgage faster than the original term allowed) may or may not be sensible:
- Repayment of other forms of debt, carrying higher interest rates, should be higher priority.
- You should ensure that you have built up a sizeable rainy day fund (1 year or more of family net income) before overpaying a mortgage.
- You should also focus on building up a cash fund to deal with foreseeable family events before overpaying your mortgage.
Financial planning for family events
- It may be advisable to ensure that your family has protection (e.g. life insurance, health insurance and income protection) against unforeseen events ahead of overpaying your mortgage.
If all these concerns are addressed, it may then make sense to overpay your mortgage and reduce your interest bill.
Handling personal loans, car loans and overdrafts
Personal loans, car loans and overdrafts tend to be an inefficient form of debt. Rates can commonly run at between 10% and 15% per annum. Typically, you will have a given term in which to pay off the loan – however it makes sense to get rid of this form of debt as quickly as you can if you can afford to do so. The interest payable on personal loans will impede your other financial planning.
Handling credit card and store card debt
Credit cards can be extremely convenient for arranging instant purchase of an item or service, but their interest rates are far from convenient. Credit card interest rates are commonly high and can exceed 20% per annum. Credit cards and store cards will tend to apply very low minimum repayments. Unless you have significant financial obligations, you should not stick to the minimum repayment, but should seek to repay credit card debt as quickly as possible.
The ideal way to use a credit card is to repay on a monthly basis the entire balance of the card. This way you get the benefits of convenience without the costs of the punitive interest rate commonly applied to this form of debt. Better still, however, keep as much spending as you can on a debit card and prevent yourself incurring credit card debt at all.
It may on occasion be possible to defer interest on credit card debt by switching to a new credit card provider with an introductory offer. Moreover, you should ensure either that you are able to use the offer period to repay the outstanding debt, or that the rate after the introductory offer has lapsed is lower than the rate you originally paid. Ultimately, moving credit card debt only defers the problem but does not resolve it.
If you have either no mortgage or a very low mortgage relative to the value of your house, but have large personal loans or credit card debt that you are struggling to repay, it may make sense to consolidate your debts.
Some lenders may allow you to consolidate all your debts into a mortgage. Alternatively it may be possible to consolidate all your non-mortgage debts into a personal loan. From your viewpoint this may make sense, as it will reduce the rate of interest you have to pay. You should however bear the following points in mind:
- Lenders are considerably less eager now than they were in the past to facilitate re-mortgaging.
- If you have a tracker mortgage, you should probably not sacrifice it to consolidate loans, as the total interest rate you end up paying will almost certainly be higher than previously.
- You will need to be able to show that under the new structure you will be able to meet loan repayments.
Finding your debts a burden?
You may not be in the category of having serious debt problems, but may still be finding your debts a burden. To make that burden lighter we strongly recommend the following:
- Formulate a budget to compare your income to your spending and consider what spending items could be cut.
- Ensure you are taking advantage of all tax relief that you may be eligible for.
- Ensure that you are receiving all your social welfare entitlements.
Social welfare entitlements
- If your financial difficulties stem from an accident or illness that is preventing you from working, check whether your employer provided an income protection policy against which you can claim.
- Consider renting out a room in your house.
- See if you can save money on utility bills such as gas and electricity by switching supplier.
- Consider whether you could take on part time or additional work to increase your income.
- If you are not in negative equity (i.e. if you do not owe more on your mortgage than your house would currently sell for), consider selling your house and buying a less expensive one.
Not all of these methods of improving a personal budget will work for everyone. However sometimes it is possible to make simple changes that greatly improve your financial situation without greatly impacting on your standard of living.