When it comes to managing your money, you might think that it would make sense to get straight into clearing the debt down, but first there’s another job you need to do, and that’s to save a starter emergency fund. The reason for this is to cover most likely eventualities without you having to go further into debt to cover them.
Imagine two scenarios. You’re serious about paying down your debt, and you’re doing well. Then out of the blue you rear-end someone at a roundabout, and you have a £250 excess to pay on your insurance.
In the first scenario, you just don’t have the money to hand, so you dip further into your overdraft or put it on a credit card. In scenario two, you draw from your starter emergency fund and move right along with your day.
You haven’t had to extend your debt – the very thing you’re trying to pay down right now – and you can breathe easily. A starter emergency fund simply prevents you going backward at a time when you’re gathering momentum in a really positive direction.
Ideally, this should be £500 – £1,000 in size, and should be held in an accessible bank account, but not in your everyday spending or bills account. Open another account just for this money. Make sure you can get at it, but don’t carry the bank card around with you – you may be tempted to spend the money on something which isn’t an emergency.
Where is the money going to come from? Well, for the time being, you’re going to pay minimum payments on all your debts, and scrape this money together as quickly as you can.
Remember when you wrote down the minimum payments on all your debts, and I said you’d need to find more than that each month to really make a dent? Well the ‘more’ that you’re finding needs first to go into building up your starter emergency fund.
So, if your total minimum payment if £300 per month, and you have decided you’re going to find £500 per month to pay down debt, then the £200 extra is going straight into your starter emergency fund until it is £500-£1,000.
Which is it? £500 or £1,000? I think that comes down to income. If you’re a low-earner then £500 will probably suffice to cover anything that’s likely to come your way. If you’re earning say £25,000 or more per year, you’ll probably want to aim for £1,000, as chances are your costs will be a bit higher each month and any surprises might be that much bigger too…
Look everywhere for money to get the emergency fund built. Take extra shifts or even a second job for a few weeks; sell some stuff that you don’t need or whatever – just get that money together as soon as you can. Aim for three months if at all possible. It might take longer, but a short target like that really focuses the mind.
Consolidate if you can, but Tread Carefully
When looking at your debts, there may be opportunity to consolidate to make things a bit easier. For example, you may be able to take out an interest free credit card and shift multiple card debts onto that. There will be fees for doing so, but chances are that you may still be better off, especially if you’re paying much higher interest rates on the other cards.
Please don’t consolidate using your mortgage. That’s not really fixing anything, it’s just extending the debt over a MUCH longer time and making you forget about it rather than putting it right. For my money, there’s too much risk that in doing that you’ll revert to bad habits, having wiped the slate clean at a stroke.
Take care when borrowing from family to consolidate debts. I have seen money get in the way of family relationships too often to think this is ever going to be a good idea. So, if your family member offers to help you out by lending you money to pay off debts, I would advise against it, because there’s a very good chance it’ll destroy the relationship before it fixes your financial issues.
You will feel guilty and edgy every time you’re around them, which will really take the shine off family gatherings. You’ll feel like they’re judging you every time you show up in a new t-shirt, because that’s money you could have paid them back more quickly with!
Everyone is different, so make your own call on this, but my general rule is never to borrow from – or lend to – family. If you must do it, I suggest you draw up a formal repayment schedule and pay interest, so the lender is getting something out of it.
Tread carefully when consolidating. Avoid family debt and mortgage consolidation. And make sure you check Ts&Cs of balance transfer credit cards – don’t make your situation worse inadvertently.
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