About time. I was taught Pythagoras’s theorem (something I think I’ve used once in my life: when working out the size of a widescreen TV!) and the atomic weight of elements (nope, can’t say I’ve ever used that), but for some reason compound interest and budgeting was never deemed important enough to mention.
I am fortunate in that I come from a family that was always careful with money - I still remember getting banished from the dining room once a month so my Father could spread out all his receipts to work out where the money went; we used to have lengthy investigations if he couldn’t account for even a few pence! For those where money was less tight or whose parents were less careful, budgeting is not something that will necessarily come naturally.
The only people who will lose out from this are those offering financial products that are poor value for money, store cards and ‘premium’ current accounts for example. If they only taught one lesson it would be worthwhile - if your outgoings regularly equal or exceed your income you will, sooner or later, get into difficulty; do something about it now, not when it happens.
They sound great - transfer all your existing loans and credit cards to a debt consolidation loan, only deal with one creditor and, because the loan is payed off over a longer period, the monthly payments are lower. Right? Yes, in theory, but the reality can be very different.
Suddenly you find yourself with cards that have credit available, banks willing to lend you money. After all, your debt consolidation loan has brought your monthly payments down. Of course, to start with you tell yourself you’re going to be careful, you’re not going to take on any more debt. But then your car needs repairing, or you feel that you deserve a holiday, and before you know it your cards are maxed out again and you’re back where you started. Only this time it’s worse: your debt consolidation has a charge on your house, so if you can’t pay it the lender can force the sale of your home.
An article in the Telegraph warns that taking out a debt consolidation loan can often signal the start of serious financial problems:
According to the Consumer Credit Counselling Service charity, debt consolidation loans only benefit a minority. In an analysis of thousands of people who had taken out these loans, it said 97 per cent would have been better off by taking alternative action.
It is very hard to think of any circumstance where a debt consolidation loan is a good idea, unless as an absolute last resort, and even then only if you are very disciplined. If you are having difficulty paying unsecured debts there are other mechanisms in place to help, IVAs for example.
An example in today’s Observer also gives an example of how expensive these types of loans are in the long term:
A personal unsecured loan of £15,000 will cost £300 a month over five years, compared with £100 a month if consolidated into a mortgage. But over 25 years this spirals to more than £33,000, compared with £17,500 payable on the loan.
With interest rates on the rise, many more people will be finding themselves in financial difficulty, with loans and credit cards they cannot afford to pay. If you are one of them, think very carefully before taking on a debt consolidation loan, and consider all options.
Another warning from a major financial company about the level of insolvencies, this time from advisors Grant Thornton. They are expecting over 30,000 people to go bankrupt or enter an IVA in the first three months of 2007, 10,000 of which will be as a direct result of overspending at Christmas. The months following Christmas are traditionally the busiest time for insolvencies, and they are expecting this year to be the busiest yet.
Struggling with debt because of a change in circumstances - unemployment or illness, for example - is one thing, but to become insolvent simply by overspending is just reckless. The question is, should the lenders bear some of the responsiblilty for lending to people who are already struggling with their debts?
Over the last 5 months the Bank of England have raised interest rates from 4.5% to 5%, with monthly increases of 0.25% in August and November. Compared with the low of 3.5% during the summer or 2003, many people are starting to feel the pinch as mortgage and credit card repayments increase, and are worried about further increases.
If you’d read the BBC article on house prices yesterday you may be forgiven for thinking that 5% is as high as interest rates are going to go, and the only direction from here is down. Wishful thinking that may be for many, but unfortunately it’s unlikely that 5% will be the peak.
The financial futures markets have already priced in an increase of 0.25% in February, with another 0.25% rise a distinct possibility later in the year, and you only have to look around you to see why:
- CPI (inflation excluding housing costs) is 2.7%, above the 2.5% target, and trending up.
- RPI (inflation including housing costs) is 3.9%, and even then many people do not feel this reflects true inflation (how much has your council tax and energy bills increased by this year?.)
- Mortgage lending is still at record levels, suggesting that the two interest rate rises this year have not quelled the public’s appetite for long-term debt.
The high RPI also means that workers will be demanding larger pay rises. Local government unions are already demanding 5% (compared with the 2% promised by Gordon Brown) and unions and workers in the private sector are likely to follow, putting more pressure on inflation.
I expect interest rates to be at least 5.5% by the end of 2007. We’ve been enjoying exceptionally low interest rates for the last 5 years and it’s easy to imagine that they’ll stay at this level for ever. This is especially true of first time buyers who have never experienced high rates. It’s only 10 years ago that rates were at 6.75%, and even that would have seemed low compared to the 15% in 1989. With the record level of mortgage debt the worry is that anything over 5.5 - 6% will see a huge increase in the number of homes repossessed.
Accountants KPMG say that £1.4bn of debt has been written off by creditors in 2006 due to the increase in use of Individual Voluntary Arrangements (IVA). Approximately 110,000 people became insolvent this year, the first time the figure has been above 100,000. The average person taking out an IVA owed £52,000 and had agreed to pay 39% of their debt.
This is a frightening figure that can only get worse as interest rates increase, as they are expected to do in the New Year. IVAs put creditors in a tricky situation: they at least receive some of the money owed, unlike if they forced bankruptcy, but there is only so much bad debt they will be willing to write off. The only outcome I can see is that they will tighten their lending criteria, making credit harder to get.
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