The real cost of debt

If you think nobody cares if you’re alive, try missing a couple of car payments.

— Earl Wilson

Debt’s bad, debt holds you back, debt ruins lives, blar blar blar. I’ve banged on long and loud about debt and the problems it causes. But even with writing article after article and telling everyone I meet about how bad debt is, I discover debt is still around.

So let’s play a good game. It’s called “The Real Cost of Debt”, with a subtitle of “Money You Like to Earn Then Give Away Immediately to Other People so That They Can Become Rich and You Continue Working Until the Day you Die.” Catchy!

The rules are like this. Make a list of all the debts you have, mortgage, loans, credit cards, overdrafts, pay day loans, late library fees, everything. Put all the names in one column and in next column how much you owe in total. Then in the third column put the interest rate of each debt. Now we’ll work out how much each piece of debt costs us every month. To do this I used various calculators from the amazing calculator.net

For an example we’ll use a fictional person, Wayne, with some debt.

  • Mortgage – £280,000 – 3%
  • Car finance – £20,000 – 4.9%
  • Credit card – £10,000 – 19.9%
  • Bank loan – £5,000 – 3.6%
  • Total debt £315,000

Now let’s look at the amount of interest paid on each piece of debt.

Mortgage – £280,000 – 3%
The mortgage has just begun so Wayne will be paying the highest amount of interest as he has 32 years to repay his debt, and the interest is highest at the beginning of a mortgage.
The first year of interest will cost in total £8,327.59.
An average of £693.97 a month!

Car finance – £20,000 – 4.9%
With his new house Wayne also had to buy a new car that he’s financing over 5 years.
The first year or interest will cost in total £449.72.
An average of £37.49 a month!

Credit card – £10,000 – 19.9%
Wayne bought a load of junk to fill his new house, like a second TV for the kitchen and a rowing machine for the garage, although it’s already full of unused stuff from his previous house.
As Wayne is paying so much back on interest already, he decides that with his credit card he will only repay the minimum payment of £166.
Working out interest of a credit card crashes my calculators. That’s how big it is.
The first year or interest will cost in total £1,705.
An average of £142 a month!
Oh yeah, and just to mention, that £10,000 will take 35 years to repay and cost £59,678.30 in interest alone. Almost 6 times the cost of the initial debt. That 12 slice toaster better be worth it!

Bank loan – £5,000 – 3.6%
Wayne owed some people some money. Don’t ask. So he got a loan from the bank over 5 years.
The first year of interest will cost in total £94.
An average of £7.85 a month.

So let’s finish the game and add up the scores of how much each debt costs Wayne per month.

Mortgage £693.97
Car finance £37.49
Credit card £142
Bank loan £7.85
Total £881.31, just in interest! Remember I didn’t include the principal amount of the debt where he actually pays for his house and car.

That’s a yearly interest payment on debt of £10,575.72!

If you put that in the stock market, and got a 10% return for the next 30 years, and you never added another penny to it, after 30 years you’d have £184,539.99.

That, my dear friends, is how much debt is costing you. And remember, the above is only for 1 year! There’s loads more years of paying back interest when you’re in debt.

Imagine putting £881.31 a month into the stock market with the 10% return and 30 years. You’d end up with £1,818,004.

Debt. It’s a right git, I tell you. Do everything you legally can to get out of it as fast as you can.

Save 1%

Motivation is what gets you started. Habit is what keeps you going.

— Jim Rohn

The first time I “really” realised I needed to save money was in my thirties. Far too late, but not too late. I often set myself a New Year’s resolution of saving £1,000. I normally got close to achieving it, then some small “emergency” popped up, or what I thought was an emergency at the time, but really was more like a “want” and I had to spend what I’d saved. The £1,000 felt like the other end of the galaxy. No matter what I did, I couldn’t achieve it. The problem was, the things I was doing to save, were not correct. Some of the things I did were:

  1. Not saving automatically – the money I should have contributed every month, £83.33, was not coming directly out of my bank account (standing order) as soon as I got paid. I needed to move the money manually, and if there was money to move, I didn’t do it, as I often found something else to spend it on.
  2. Not paying myself first – As I was not saving automatically, I didn’t pay myself first. Paying yourself first means as soon as you get paid, before you pay the mortgage/rent, electricity, gas, etc, you pay money into your savings. I never wanted to be without money during the month, so I held off until the end of the month, and told myself I’d move the money then. But or course, at the end of the month there was no money left to move. If I had paid myself first, I would have simply readjusted my spending through the month to compensate.
  3. Not having an emergency fund – By not having money saved in an emergency fund, when an emergency hit, I had to use what I’d saved of the £1,000, meaning I never got to save that £1,000 by the end of the year.

By not utilising the three above best practices, I set myself up to fail. The problem was I simply didn’t know about the three things above. I was financially naive. I realised I’d had this New Year’s resolution for the last four years and had never achieved it. Somehow, without realising it fully, I began searching YouTube and started finding ways to become better at saving money.

The first video I discovered was from Brian Tracy called The Absolute Best Ways To Save Money. In this video he suggested saving 10% of your net salary (salary you get in your bank account after tax, pensions, healthcare, etc). 10%! Jesus, I couldn’t believe it. Where was I going to be able to save 10%? The man must be a raving lunatic.

Note: 10% really is the industry standard. It’s the minimum the financial industry says you need to save. Most people say more than 10%. In the FIRE (Financially Independent Retire Early) community they say save 50%+.

Anyway, back to Brian Tracy. He’s saying save 10%. That just couldn’t be done. Then he said, if you can’t save 10%, then start with 1%. Now that is a number I could… probably, make. Brian Tracy said, if you can only save 1% then just save 1%. It’s not the amount that you’ll be saving that changes your life, it’s the habit that you form.

Immediately after watching the video I watched it again, to make sure I didn’t misunderstand. Then, straight after that, I put a reminder in my iPhone calendar to save 1% of my net salary as soon as I got paid. I was going to pay myself first!

So profound was this knowledge, I told several people, quickly, of my plan. Note: often a bad thing to spread the word about your financial goals. One person actually laughed and asked what I’d do with the 1% of money saved. I ignored the cretin. I had this 1% rule so fixed in my mind that as pay day approached, I watched the video again several times. Brian Tracy turned into Micky and I was Rocky. Every time he mentioned in the video I should save 1% I got more charged up. I was going to do it.

Then, on the morning of the 26th of that month, my standard pay day date, I woke before 5 o’clock, opened my mobile banking app and moved 1% of my net salary into my ISA. It felt amazing. The money was gone, tucked into an ISA: safe, secure, tax-free, and all mine.

I must have looked at that ISA balance 200 times that month. And when the end of the month came, and I realised I’d not spent it, and the following day I was going to do it again, I knew I’d somehow, through sheer YouTube serving content luck, stumbled onto the domino video, the spark plug video, the starter pistol video. There was no turning back. The next day, when I got paid, I once again moved 1% into my ISA. Same happened the following month. And the one after that. I did this for 6 months. There was little showing in that ISA, but that didn’t matter. The habit was formed.

In the video, Brian Tracy said once the habit is formed, we should increase our percentage contributions and raise them, even by a percentage. Still completely financially naive, I thought that going to 2% was impossible. I continued Googling, looking at videos on YouTube and stumbling across podcasts. Once I found some podcasts and heard that all the experts I was listening to: Warren Shute, Pete Matthew, Andy Hart, were saying the same as Brian, that 10% is the minimum, then I knew I had to take the leap and increase my percentage contributions, and that’s what I did.

I’m happy to say I’ve completely passed the 10% mark a long time ago and continuing to increase my contributions’ percentages on a regular basis. My goal is to be like the FIRE blogger The Escape Artist and save 50%+. Let’s see.

Note: The Escape Artist’s blog is amazing. Treat yourself and read every post he’s done. He’ll open your eyes and make you laugh.

Nothing begins until debt dies

This would be a much better world if more married couples were as deeply in love as they are in debt.

— Earl Wilson

Debt is a right git. Once it’s got you in it’s filthy paws, it does everything to never let you go.

What is debt?

Debt is money you borrowed. An example is you take a loan to buy a product, such as a new shiny television. It cost £500, so you borrow £500 from a bank as a loan. You then have to repay that £500. Almost always, debt comes with interest. Interest is an amount of money, usually a percentage of the amount borrowed, that you pay to the money lender, such as a bank, as a reward for loaning you the money. Why else would they risk their money to you if they are not getting something in return?

For arguments sake, let’s say you borrow £500 with a 1% interest rate. You pay back £100 a month. After 5 months you will have repaid the £500, but the loan will still not be cleared as you also needed to pay the interest each month. So the loan of £500 actually cost you £501.25. Maybe that doesn’t sound too bad for the use of the money. But, remember, that’s only with a 1% rate. Try and find a loan for 1% and you’ll be looking for a needle in a haystack. Credit cards often charge 19% so in the same space of time you’ll have repaid £523.99. Store cards are around 29% so you’ll have repaid £536.82. And payday loans, which are only for the desperate and financially naive, can be 100%, so you’ll have repaid £631.66. Now you see the problems with taking debt.

Debt costs you money to repay. The deeper you drown in debt, the worst it becomes. People often end up so far in debt that they continue borrowing more hoping somehow this will help, but all it does is drag you further down. Debt can have a terrible impact on your financial life. If you begin to miss payments, default on a loan, then there can be serious implicates on you, such as you could go to court, you will ruin your credit score and not be able to get other forms of debt, such as a mortgage, resulting in you renting all your life, wasting money and having no home to pass onto your loved ones. Debt also causes stress. People often struggle to sleep at night, become unhappy, have friction between relationships, the list goes on and on.

So what’s the answer?

Level 1

The first thing you need to do is make a life long agreement with yourself to stop borrowing money. Write it down. Write it in anyway you want, but write something like, “I chose never to borrow again.” And then sign it. Yes. Sounds stupid, but sign it. No one will know.

The only thing that borrowing money has done for you is to get you into debt. You need to make tough decisions.

An example is you and your family have a summer holiday every year. You use debt to fund this. When next year comes you must sit down with your family and say you cannot go on holiday. You don’t have the money for it, and you are not willing to go into debt to fund it. Instead, have the holiday at home. Summer is a pleasant season in Britain. We often have hotter days than in Europe, so have the holiday at home. A day in the garden. A day in the woods. A day by the river or at the seaside. This home holiday will be so much cheaper, and if you put a lot of effort into it, everyone will have fun and won’t miss boiling, dusty Spain with tap water you can’t drink and uncomfortable beds and blistering sun-burnt skin.

Level 2

Once you’ve made an agreement to no longer go into debt, you now need to find out everything about the debts you have.

Who is the provider?
What is their email address and telephone number?
What is your account number with them?
How much debt do you owe them?
What is the interest rate on that debt per month?
What is the minimum payment you have to pay them?
How do you pay them? Direct debit, pay in a bank etc.

Once you have all that information, list each debt side by side and put them in order of the lowest amount of debt in the left hand column to the highest amount. Also when you’ve done this, add all the totals of the money you owe so you have one total debt figure.

Whatever the amount, small or ginormous, stay focused. Only someone poor with money would bury their head in the sand now and borrow more. That’s not you. You’ve made a pledge with yourself to never borrow again.

Level 3

Now make a life long agreement with yourself and choose to repay your debts in full, as fast as you can. Write it down. Write it however you want, but something along these lines, “I borrowed the money, so it’s my responsibility to repay it, in full.”

Now let’s look at how to repay it.

First of all we need to make some fake debt up for this example. Let’s pretend I’ve got the below debt.

Credit card A
£2,500
19%

Credit card B
£500
18%

Car Finance
£7,000
11%

Store card
£3,000
29%

Loan
£1,500
8%

In total I have £14,500.

Now I’ve made the pledge that I will never borrow again and I will repay my debt.

Option 1: Get help.

There are a number of organisations that help people with debt if they are struggling or can’t pay it. Best to discuss this with the Citizen’s Advice Bureau and they can offer help. I know nothing about these organisations so cannot comment.

Options 2: The Snowball Effect – highest interest rate.

Financially beneficial to your wallet. The debt to tackle first is the store card at 29%. The interest this creates is killing your financial self. You should pay the minimum payment on all of your other debts apart from the store card. On the store card you throw every penny at it until it is repaid. Once that’s done you move onto the next highest interest rate which is credit card A. Again, you pay the minimum on all other debts and throw as much as you can at credit card A. The plus point here is you are no longer paying off the store card, so whatever money you threw at that, plus the minimum payment you were paying on credit card A, now accumulates and you are hitting the debt with two loads of payments. Once you pay off credit card A, you move onto credit card B and throw all your money at that. And this snowball of paying off debt continues to roll picking up more and more money as you pay off another debt. You do this until you are debt free!

Option 3: The snowball effect – lowest owed amount first.

Option 2 is by far the best for your wallet. Option 3 however has great psychological power. Option 3 says forget about the interest rate, you’re already in bad shape. Go and pay off the smallest loan first. So rather than focusing on the 29% store card, you focus on credit card B at £500. For all other debts you pay the minimum payments, and you throw everything you have at credit card B. You will get this debt repaid quicker making you feel like you’re getting somewhere faster. It’s one less debt to worry about. And it’s one less debt generating interest. Once you’ve repaid the lowest amount, go for the next lowest, which is the loan of £1,500. You’ll be throwing all the money you were giving to credit card B to the loan, plus the minimum payment you were paying to the loan, so again, you’re hitting the loan twice as hard. Once that’s repaid go to credit card A at £2,500. And on and on until you’re debt free!

My favourite option is option 3. But it’s down to the individual. There are other things you can do to help repaying your debt.

The first is get an emergency fund.
The second is create, use and stick to a spending planner.
The third is call your providers and haggle, which is an additional option called option 4.

Option 4 – The haggle

Now you’re not a pushy person, you don’t like conflict, you’re easily sold to and couldn’t sell water to a thirsty millionaire. Don’t worry. The haggle isn’t like a stock market film from the 1980s. The haggle is this.

You call your provider, credit card company, loan company whoever, and, ever so politely, you tell them you want to review your terms with them. You tell a little white lie and say you’ve spoken to their competitor and they’ve offered you better terms. You say you’d love to stay with them because the customer service is so excellent. This will please the person answering your call. Life in a call centre can be pretty tough and they don’t often get compliments on all the amazing work they do. You say you’d like to stay, but you need a better offer. Before they can agree or disagree you state what you want. You want your interest rate to be 0% for X number of months. Go high. Don’t say for the next 3 months. I had a credit card with 39 months at 0%, just because I asked for it. And what’s the worst they can say? “No.” But what if they say yes? If they do you get 0% interest for many months meaning everything you pay to that provider goes off your principle debt and not as interest. If they do say no then ask them what they can do for you? If they provide a lower interest rate than you have now then take it. Anything lower is good. Of course read all the terms and conditions to this deal. But if it sounds good, then take it. Every little helps. If they say no and ask you if you want to cancel, you can tell them you have to pop out for a while and will ring back later. That way they don’t cut you off. Then you have a choice, you can go and try and find one of their competitors, tell them you have a debt with your current provider and want to transfer it to them, but only at 0% and for a long time. If they accept this offer, move your debt. If they don’t, can they improve what you have with your current provider? If so, take it, but read the terms and conditions. Even if you got 1 of your debts like this, it will be a benefit to you. If you got them all, that would be amazing.

And don’t forget, these providers want to keep you. It costs them lots of their money to acquire a new customer. You’re in debt for a reason, because previously you were poor with money. The provider doesn’t realise you’re becoming financially aware. You’re playing the game by their rules and you’re going to win.

Conclusion

Whatever option you choose, it needs to be right for you. The aim is to repay the debt and become debt free as fast as you can. You need to stay focused and disciplined. You need to constantly revisit the pledges you made of never going into debt again and repaying the debt if full.

On a side note, here are some great resources I’d recommend about debt: