In early January 2013, the news we had all been expecting began to trickle out from the nation's economic forecasters. The numbers show that personal debt in the UK has soared almost 50% since the previous quarter. As reported by the Guardian and other sources, the typical UK family now owes nearly £8,000 in unsecured credit. That is up from £5,300 at the start of 2011.
Perhaps even more disconcerting is the fact that roughly one in three Brits believes the personal debt crisis in the UK is hopeless. Many do not believe they will live to see the day when they are completely debt-free which, as a result, tends to lead to less personal responsibility when it comes to spending. It is a situation that needs to be turned around desperately. And it can be, if people get back to the old, tried-and-trusted principles of personal financial management.
The Unsecured Credit Problem
At the heart of the personal debt problem is what is known as "unsecured credit." As the name implies, unsecured credit is the type of credit that requires no form of collateral as a backup for default. Credit cards are the number one form of unsecured credit in the West. Once a consumer is able to get a card, they can spend freely, up to his limit, without worry of the card issuer seizing their personal property in the event that they cannot pay their bills.
By contrast, secured credit is something like a mortgage or car loan. The debt is secured by the property that was purchased through the loan product. If the consumer defaults, the creditor can seize the home or car and sell it to recoup as much of the money as possible.
While secured credit is generally considered safer for everyone involved, unsecured credit has always been that ticking time bomb. The inherent weaknesses of the unsecured credit system make it too easy for problems to arise, problems that, when they do arise, quickly end up in a downward spiral. The two main deficiencies inherent to unsecured credit are:
- Lack of Collateral - As previously stated, unsecured debt has no collateral backing up the good faith of the consumer. As such, he or she can purchase goods and services freely without having to worry about what would happen should they not be able to make their payments. This is an open invitation to spend without discipline.
- High Interest Rates - In order to reduce some of the risk they take with unsecured credit, lenders typically charge very high interest rates when compared to secured credit. The higher interest rates allow lenders to collect more money for as long as possible so that their losses will be less in the event of a default.
When you combine these two things together, you have a very volatile situation. All it takes is one or two missed payments, and the subsequent penalties and higher interest rates add enough to the existing debt to make repayment out of reach. Once consumers adopt the mind-set that they'll never be able to pay what they owe, the temptation to become even more reckless with their spending is too great for many to bear.
Consumer Debt Creates Other Problems
Very few national economies can remain viable when consumer debt soars. Why? Because consumer debt creates new problems that further weaken an economy at its roots. Because a national economy is built on the individual economies of families, an entire nation can be financially undermined if the majority of its families are facing high amount of debt.
Some of the other problems consumer debts create are as follows:
- Defaults on Secured Credit - It may seem counter-intuitive but debt-ridden families have a tendency to allow their secured debts to go unpaid rather than adopt the principles necessary to control their finances. That translates to more defaults on mortgages and car loans. When unsecured debts go unpaid, consumers lose their property and lenders have less money to let out into the market.
- Short-Term Loans Increase - People feeling overwhelmed by personal debt often find they have trouble meeting basic needs like utility bills. Unfortunately, the temptation of short-term "payday" loans is always there. Consumers who use this type of loan product to get by until the next pay cheque end up further in debt with every loan they take.
- Increased Borrowing Opportunities - As consumer debt increases, consumer spending decreases. In order to keep businesses viable, manufacturers and retailers need to find creative ways to move their goods and services. They do so by creating more borrowing opportunities through things like in-house financing, delayed payment options, etc. Again, this only perpetuates the debt problem.
When you step back and look at the personal debt crisis from a "big picture" view then it is easy to see why consumers are discouraged and fearful that they will never get out of debt. However, financial advisers have been consistently preaching the same solutions for hundreds of years. They preach those solutions because they work.
Old, Tried and True Solutions
It has been said that the more things change, the more they stay the same. That's probably truer than any of us really know. When it comes to personal finances, it is clearly demonstrated in the evolving debt crisis and the proven solutions that will solve it. The solutions are nothing fancy, glamorous, or sexy; they are based on concrete principles that work almost every time they are tried.
If you find yourself drowning in a sea of personal debt, the following steps will get you out. Keep in mind that it takes time and discipline to work your way out of debt. You didn't get into debt overnight; you will not get out overnight either.
- Develop a Budget - It seems like such a simple thing, but it will do wonders for your personal finances. A budget is necessary in order for you to understand fully how much money is coming in versus how much is going out. A budget also serves as a blueprint for how you will be spending your money in the future.
- Cut Expenses, Raise Revenues - This step is the hardest for most people because it requires the most drastic changes. However, it must be done. When you create your budget, the monthly payments you make to pay off your unsecured credit will be part of your spending plan. Therefore, you are going to have to cut expenses and/or raise revenues in order to make those payments.
- Pay More Than Minimum Amount - As you do work your way through paying off your unsecured credit, make sure you do so by paying more than the minimum amount due every month. This is the only way to reduce the interest you are paying and get the debt paid off.
- Prioritise Your Debt - With a good plan in place, the next step is to prioritise your debts. Concentrate on paying off the ones with the highest interest rate first. Obviously, continue making monthly payments on the lower rate debts so you do not incur penalties, but any extra money you realise from your budget should go to your high rate debt first.
- Get Rid of Credit Cards - It does no good to begin down the road of debt elimination if you are going to keep repeating the behaviour that got you into debt to begin with. Therefore, you need to destroy your credit cards and close your accounts. It is entirely possible to live without credit cards; millions of people do it every day. It takes some getting used to but once you have been without credit cards for a while, it's not hard at all.
- Practice Frugality - Lastly, learn to practice frugality. For example, rather than buying brand-new clothes off the rack, shop at used clothing outlets instead. Rather than purchasing a brand-new car, look for a quality used car that's a couple of years old. Once you get out of debt and learn proper financial management, there will be plenty of time to enjoy new things again. But now is not that time.
Wants vs. Needs
The biggest obstacle to recovering from personal debt issues is failure to come to grips with what is necessary and what is not. Going back to the idea of cutting expenses, consumer electronics provide a great example of this principle. We can further zoom in on one manufacture in particular - Apple - to drive this point home.
The iPhone is a wonderful little gadget loved by millions around the world. Nevertheless, is having one necessary? No. A mobile phone is a luxury, NOT a necessity. This is one area where all of us could cut expenses if we were willing to give up the convenience of the mobile phone.
By the same token, if your work makes having a mobile phone absolutely essential, there is no need to spend so much money on an expensive iPhone when you can get a very good Android for half the price. There is no need to spend a lot of money on an unlimited data plan when you could go back to using your phone for its intended purpose: making calls.
In the end, this comes down to perceptions. Most of us who are suffering under a mountain of consumer debt find ourselves in that position because we have confused what we want with what we actually need. Most of us could get rid of an awful lot in our lives and save a lot of money at the same time.
It is quite likely that without systemic changes most UK residents will probably never escape the consumer debt prison. However, you don't have to be one of those individuals. With sound budgeting and spending practices in place, you can repay all of your debt within a reasonable time. When you are debt free, it will be a huge load off your shoulders.
If you need help formulating a budget and repayment plan, do not be afraid to ask. There are countless numbers of financial advisers ready and willing to help. There are also numerous credit counselling agencies and other non-profit organizations offering free assistance to debt-ridden consumers.
Help in getting your debts under control is available from fee-based services, non-profits, and debt charities. The links below will take you to the websites of some of these organizations. Use caution with fee-based organizations that may offer you very little relief compared to the fees they charge.
Moore Stephens - An international consulting and accounting company serving both commercial clients and individual consumers. They offer debt-counselling services all over the UK; your initial, face-to-face consultation is absolutely free.
Consumer Debt Solutions - An agency offering a variety of debt solutions ranging from IVA’s to trust deeds. Everything they offer is thoroughly explained so you will know what to expect when you meet face-to-face with a counsellor.
PayPlan - One of the UK's largest debt management and advice organizations. They offer free consultations, debt management plan, IVA’s, and trust deeds. They are funded through voluntary donations from creditors who value their services.
Step Change - UK charity with more than 20 years’ experience helping consumers get out of debt. Their free financial advice and debt counselling have helped more than 2 million people create and implement debt reduction plans.
Citizens Advice Bureau - Offers comprehensive information on financial management and debt relief. You can take advantage of the information online or visit an office for face-to-face consultation.
Christians Against Poverty - A non-profit charitable organization offering free debt counselling through offices located in more than 200 churches throughout the UK. Their faith-based approach to debt reduction is different from what you will find with most secular organizations.
Debt Support Trust - Another UK charitable organization offering free debt counselling and financial advice. Their website provides a debt analysis tool allowing consumers to find out, in just a few minutes, whether the services the charity offers can help.
The following links will take you to well-known comparison websites where you can search for debt consolidation loans. Keep in mind that some of these loans are secured while others are unsecured. Before you choose an unsecured loan, be sure you understand the ramifications.
Go Compare - Compare rates for debt consolidation loans through this site's partner, LoveMoney. You can also take advantage of some helpful information the site provides about getting out of debt.
Money Supermarket - Here you will find a number of debt solutions from which to choose. On this page there is even a debt calculation tool allowing consumers to find appropriate products and solutions based on individual circumstances.
Money.co.uk - This site offers comparisons on more than 180 debt consolidation loan options. Everything is laid out in an easy-to-read grid that includes things like current APR, maximum LTV ratios, and available amounts.
Totally Money - A site where you can get quick comparisons on several different types of loans, including debt consolidation loans. Just enter a minimum of information and you are on your way.
Money Saving Expert - If you need help understanding the debt problem and how to get out, this site offers a ton of useful information. Most of the common debt related questions people ask are answered here.