Thursday, 18 October 2012

Getting Out of Debt - Part 2 - Managing Your Money

Managing your money isn't simply taking care to spend less than you earn. There's more to it than that. In fact, unforeseen circumstances can catch out even the most careful of us and scupper plans made with the very best of intentions.

Think about this:

Buying in bulk results in making a saving. It has to otherwise what would be the point? However, it can also make you less well off.

Strange, but also true.


One aspect of money management is cashflow. This is often talked about in the context of business, but is rarely mentioned when talking about family financial matters. I think this is a mistake. Here's a slightly extreme example to illustrate my point:
Family X are not well off and are struggling with debt. At the start of the month, Dad gets paid. He's happy because he got a particularly good bonus with that pay packet, so the family should be able to get through the month in relative comfort. Dad is looking forward to not having to worry about money come the end of the month when usually funds are low and the family hangs on by the skin of their teeth until payday.

Mum is aware that the freezer is empty and wants to fill it with food for when times are lean and they have little spare cash. She doesn't want her family to go hungry. So she goes to Costco and spends the surplus on three months worth of food which she then cooks up and freezes. 
Then the boiler breaks down, and the bill to fix it is huge... 
The family now have a difficult choice ahead of them. They can either:   
  1. Pay the bill, have the work done, and attempt to scrimp by until the following payday
  2. Conserve their money and live in the cold until payday when there's more spare cash
  3. Borrow the money, have the work done, and live without the stress
On the face of it, option 3 seems the most sensible, but when you're deep in debt, adding more to the interest you pay is not the way to go forward. When you have debt piled up round your ears, you need to hang on to your money for longer. So what's the solution?

Mum's idea of filling the fridge is a good one, but the family spending should be structured in a different way. There's an old saying "Pay yourself first" and that applies here.

Those of us who are deep in debt need to start saving.

Saving? Are you mad?? I'll explain...

To help smooth out financial humps and bumps in the road of life, every family needs a slush fund. A sensible amount of emergency savings stashed away in an instant access account that they can get their hands on when the need arises, such as when illness strikes, or job loss, or expensive car repairs.

Savings also give you some bargaining power with creditors too, but I'll be covering that in my next post. Sticking with the food, what Mum should have done is wait until the end of the month, and the following payday, spending some but not all of the surplus on food for the freezer, filling the freezer over a time period rather than all at once.

In fact, this is another good way to hold on to your money for longer. When buying something ask yourself, "Do I actually need it today, or can I buy it tomorrow instead?" Spreading out your spending over time like this, actually means you spend less.

Having said all this about cashflow, there are certain items that you should pay immediately for exactly the same reasons. Take things like your mortgage payments for example. These should be paid out from your account just after payday so you can't accidentally spend that money. You should arrange this for all your vital bills, so that when these have all gone through, the money left is yours to do as you please with for the rest of the month.

But what is a vital bill?

You need to prioritise your outgoings. Vital bills are the more important bills like gas, electricity and mortgage payments. These thing keep a roof over your head and keep your family warm and fed. Bills like credit cards, satellite TV, mobile phones etc. should have much less of a priority. In fact these lower priority bills should come below food and other vital family spending. Here's a true story that shows how prioritising your bills helps:
I knew a family who had borrowed too much and had difficulty making ends meet each month, (lets call them Family Y, because I'm going to refer back to them again later). When payday came around they paid ALL their bills up front and tried to live out the rest of the month on what was left, and what was left simply wasn't enough. It got to the point that one month, they were having to subsist on nothing but a large box of breakfast cereal because that's all the food they had left, and they had no money to buy more. As payday was still a week and a half away, the situation was desperate, and they asked me for help.
I looked at their outgoings and they had quite a few credit cards and loans, so I suggested they consolidate their borrowing, so let's see if that adds up.

Consolidating your debts

Until 2008, credit was actually quite easy to get hold of even if you had a bad credit score. If you've read a little bit about my background, you'll know I managed to run up some debt myself, after a nasty road traffic accident, and that I also worked for a mortgage company some time afterwards.

During my time there I arranged a lot of secured loans, (also known as 2nd mortgages), for customers, so I became quite adept at figuring out their outgoings from credit reports and balancing that with loan and mortgage repayments. In my own case, I decided to get a secured loan myself and consolidated a lot of my family's debt into it.

Basically, I hadn't borrowed any more money so I still had the same amount of debt, but rolling it all into one lump with one lender resulted in me paying out one affordable payment each month instead of several payments to various credit cards that originally came out to more than double the loan repayment.

But there are problems with consolidation.

You need to be very, very disciplined. Disciplined enough to close your credit card accounts and other borrowing and never go back. If you are tempted to use credit again, you can get yourself back into even worse financial difficulty very quickly and easily. While arranging loans, all too often I'd see the same clients coming back for more and more money, having run up their credit cards yet again, until they reached their own financial "crunch" point, and it wasn't very pretty to see. There were people who lost their houses over it.

Going back to Family Y.
I did a credit searches on them to find out the full extent of their debt. Then I did the sums. Unfortunately, consolidation wasn't going to work for them. For starters, they rented their home so couldn't secure a large enough loan to clear all the debt. In fact, even if they had owned the house, a suitable loan wouldn't have helped, because they still couldn't have afforded the repayments, and that may have resulted in them eventually losing their home :( 
So a bit of a dead end right? Not so! :) 
We discussed their outgoings and prioritised their bills, putting living expenses, (like food and breakfast cereal), above credit cards and loans. Mum was worried about what that would do to their credit score. I pointed out that as they weren't going to be borrowing any more money, any time soon (possibly never), that credit score was of little concern.
Then we contacted all of the creditors to renegotiate terms, (there's a good way of doing this, which I'll go into in my next post). We worked on using the budget left after vital bills and living expenses (which is also quite vital!), had been taken out. This is known as your disposable income.
Disposable Income

This is something you need to keep an iron grip over. As mentioned, this is the figure left after taking out vital bills and living expenses. When you're having trouble with debt, lenders will often want to know your income and expenditure to see what your disposable income is and therefore how much money they can squeeze out of you.

Vital bills is an easy sum to work out, you simply add stuff up, but it's important to get the "living expenses" amount right. You need to make sure you include things such as monthly bus fare or petrol/gas/diesel for getting about (work, seeing family etc.), and "treats" that I mentioned in Part 1. Obviously your budget for treats will have to be minimal, but it is actually very important. If life is bearable, you'll be able to keep to an agreed payment schedule, so budget for something like a visit to the cinema and a meal out each month, or something reasonable like that.

It's at this point I should really raise the point of who controls your money.

 The vast majority of people who are having debt problems, also experience difficulty with their banks. In fact, when you're having difficulties banks can be right sods. If this is you, then I suggest you open a "parachute" account. Simply this is an account at another unrelated bank. Remember, some banks are owned by others, so if you have an RBS account, don't go to the Nat West, as they're part of the same group. And for heaven's sake, don't open your slush/emergency savings fund with your old bank, they'll just take the money...

So what's it for? Well, you may find that every month your bank ruins your monthly budget by helping itself to your pay by way of extortionate bank charges and bouncing payments you really needed to make, but will generate more bank charges the following month and so on. These might take you overdrawn, or over your overdraft limit, whereupon, there's even more charges to be had, and so the nightmare continues and spirals downwards. The parachute account gets you out of immediate trouble.

As you may already have a bad credit score, opening another bank account isn't always straight forward but it is 100% necessary to get your pay somewhere out of reach of your existing, predatory bank. In the UK, some time ago the government legislated that banks must offer no frills, "basic" bank accounts, and even to this day, I still use mine.

What I did: I went round all the banks in the town where I worked, as I needed my bank to be immediately accessible, face to face during the day if necessary. I asked them all for details of their basic accounts, (and did a lot of research online), applied to a few, got rejected by a few, and finally settled on the Co-Operative bank. They were a good choice because I knew I couldn't trust myself to keep my affairs in order all the time, and they had the lowest charges for bounced payments etc. They also don't do overdrafts on basic accounts, which was another one of my criteria, again due to temptation often getting the better of me. Also, there are other institutions that offer bank accounts besides banks, such as the Post Office (in the UK).

Then I got my wage paid into the new account, and told my old bank they could F*** Off.

Okay, so it wasn't quite like that with the old bank, but as my wages were no longer going there, they couldn't help themselves randomly to MY money and were, all of a sudden, far more willing to negotiate a fair plan for repaying what I owed.

As I was married, I also got my Mrs to "parachute" her wages to the new bank, and we opened a joint account too. The joint account really helps, as we used it for all the bills, and bills only. What goes into that account doesn't get spent by us, so it's effectively ring fenced. What's left in our personal account is our disposable income.

Setting up Payments

Many companies love you to pay by Direct Debit, (not sure what non UK equivalents are called). The Direct Debit is an automated method of payment that enables a company to simply apply for what it wants, when it wants, from your account, provided they advise you in writing 14 days in advance. Trouble is, as fallible humans, 2 weeks is a good time to forget about stuff, and it's not like banks and companies don't make mistakes either, because they often do, and it always takes them such a long time to sort it out afterwards. Meanwhile you're left hanging...

You need to be the one who dictates when payments are taken from your account, not some external corporate body.

If you can, you should cancel as many automated payments as you can, and set up manual ones instead, controlled by you. If you can't, make sure the date a payment is taken, is convenient for you, not them, and these dates should of course, always be a day or two after your payday.

In my case, my pay day varies around the end of the month, but is never later than the 31st. All my payments are set to go on or after the 2nd of the month, so if there's a public holiday, or whatever, the money is always there ready to go, and because the majority of them are manual payments, I can easily change the dates and/or amounts very easily via internet banking whenever I want.

This has all made managing my own money so much easier, and has kept me out of trouble with the bank.

OK, that's all for today. If you have any tips of your own, please feel free to comment below. Tomorrow, we'll talk about how to deal with your creditors.

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