Money Basics - Debt
Money basics is a series of short articles where we will explore several themes that confuse and bewilder and try to break down all the legalistic jargon into plain English.
Previous articles have covered pensions bonds/endowments ISAs Life insurance.
The last in this series we will talk about debt.
Pay it off?
Traditional financial planning suggests that one should take out as little debt as possible, and only if the rate – APR – is competitive. As soon as it can be paid off it should be.
However, such a broad brush approach is often misguided and can lead to poor personal outcomes.
You should look at your attitude to risk as a start point.
If you are a low or low-medium risk investor then you’ll probably be looking to return around 3-5% over the long term. Medium or medium-high risk investors should be budgeting for a 5-7% growth rate and High or very high risk investors should be looking at 8% or more growth in the long term.
Dependent on your risk appetite you may not want to pay off your debt.
For instance, if you have a mortgage where the interest is 3.8% APR and you have money to invest, there is still a choice for higher risk investors where investing the money might make more than the interest repayments.
If, however, you have a personal loan at 16.9% APR, then paying this off early almost always pays dividends; metaphorically at least!
Make a budget
If you sit down with three months of bank statements and put everything into some column of spending or another you can look at your historic spending patterns and then construct a budget for the future.
You’ll then know how much you can actually borrow!
Do not disregard ‘one offs’. One off items of expenditure tend to be regular, just the next one off will be a different one-off? You could have a one-off expense of a new sofa in June, then in July you have a service for your car and in August you have a children’s birthday party…
So, if you are regularly saving £300 a month, you know you can afford to take on borrowing of around £200 a month. Building in additional space is very important.
The reason for not spending all that you earn is that if The Bank of England increase their base rate then your debt repayments are likely to increase. Most people have leeway in their personal budget to cut back on certain items, but having financial space can be invaluable.
Spending isn’t bad
I am one of the few IFA’s that think that sacrificing today to pay for tomorrow is not always the best approach.
Satisfaction is often found in life by achieving a balance between a good life and a reasonable plan for the future. There is no point having more money in your pension than you can spend…
Our in house Independent Financial Advisors can help you with all aspects of financial planning including pensions, investments and inheritance tax planning. If you need any legal advice, please contact the Chattertons’ Wealth Management team at your nearest office.