Are you hooked on debt?
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I know a lot about the dangers of debt.
I bought my first property in 1989 for £62,000, funded with a £58,000 mortgage. Five years later I sold it for £46,000 and had to find nearly £12,000 to pay off the mortgage.
In hindsight, I should have kept the property, rented it out, and let the rental income gradually reduce the mortgage while the value recovered. But I hated the place so much that I let my emotions get the better of me.
I felt stupid for buying a home at the top of the market and angry at seeing my hard-earned savings disappear down a mortgage black hole. I felt trapped in my property and frustrated at my predicament. It had become more of a prison than a home.
I should have put all my energy into reducing the mortgage as quickly as possible or building up savings. Instead, I decided to buy a new BMW on hire purchase.
I spent money I didn’t have to buy a car I didn’t need. But what I did need was to feel better about myself and give an outward sign to other people that I was successful — a tendency psychologists call “extrinsic motivation”.
I was spending money to get validation and acceptance of others and create a false sense of status. Over the five years that I owned my flat, I continued spending lavishly, all sustained by a constant overdraft and juggling several credit cards.
I gradually realised that I had become addicted to debt. Debt enabled me to spend more than I earned and avoid facing financial reality. It was the sticking plaster I put over my emotional pain.
I found it very easy to wander into debt but virtually impossible to clamber out. Once it had become entrenched in my life, it seemed to cling on like bubble-gum on my shoe.
I remember sitting down one day and realising that I couldn’t go on living like this. I was sick and tired of constantly juggling payments, having lenders chasing me for money and having nothing to show for my hard work. I vowed to become debt-free.
Strip away the personal details of my story and you will find a problem shared by many: the allure of cheap debt. It’s an old problem, but it’s also on the rise.
Recent research by the Joseph Rowntree Foundation found that since the pandemic the lowest income households have seen their debt increase. Of those, only 9 per cent were confident that it will fall in the future as their income rises. When you can’t cut expenses any further you have to increase income. But for those with caring responsibilities, low skills or health issues, that’s easier said than done.
Most personal debt is mortgages to buy property, but unsecured debt is also significant. I often hear the argument that debt is so cheap nowadays that borrowing is a no-brainer.
Bank of England statistics suggest that before Covid, many more people were using debt to fund consumption for non-essentials like cars, holidays, home furnishings and electronics. Using debt to buy an appreciating asset is one thing, but using it to fund consumption is another.
Using a mortgage to buy a rental property, with repayments covered by rental income, is a legitimate way to build wealth. But even this comes with risks. If rental income stops, mortgage repayments take money out of your pocket.
And when a tenant can’t or won’t pay, it can take many months to evict them. During the pandemic, when landlords couldn’t even start court proceedings, removing non-paying tenants became impossible. A friend of mine hasn’t received any rental income on his property for 16 months, which is money he’ll never recover.
Debt, no matter how cheap it is, must be repaid. Those monthly repayments reduce your ability to save and invest, as well as your flexibility to cope with a fall in income.
But repaying it can be a hard slog. I eventually became completely mortgage and debt-free. I don’t even have a credit card.
Part of my work now involves helping people to get out and stay out of debt, so they have the excess income to build savings and wealth. In my role as head of financial education at Salary Finance, a provider of salary-linked financial products, I’ve answered hundreds of customers’ money-related questions and interviewed many of them about their relationship with money and the role of debt.
I find that some people get into debt due to their own poor choices. For others it’s due to circumstances and bad luck. Most tell me that they have never learnt basic money skills like how to control day-to-day spending.
In an ideal world, no one would ever borrow money. But in the real world of social media, internet shopping, low and variable income and inadequate sick pay, people will always need to borrow money for things other than buying a house.
We need to meet people where they are today with empathy, not judgment. Rather than a lecture, people want practical help and tools to be better with money. Making progress, not perfection, is the best way to build financial confidence and win the war against problem debt.
Five steps to becoming debt-free
Create a spending plan for your money. Allocate where you will spend your money in advance, only spending the money you have. My Smart Spending System can help.
Stop borrowing money. Tell yourself that debt is not an option.
Find ways to increase your income. You need enough to meet the essentials and surplus to repay debt and build savings. Consider “side hustles” and ways to make your assets and skills generate extra cash.
Use the snowball method to get rid of your non-mortgage debts fast. You do this by putting the largest share of your spare cash each month into repaying the smallest debt.
Build an emergency fund. This gives you the ability to cope with unexpected expenses or a drop in income.