A 30% debt disaster

Neil Faulkner
by Lovemoney Staff Neil Faulkner on 06 March 2012  |  Comments 12 comments

We show how 30% debt costs 50 times more than a 5% debt and where to go from here if you're paying high interest rates.

A 30% debt disaster

Someone close to me made the naïve mistake of letting someone sell him a loan to make his time at university more enjoyable. 

He's now a decade wiser but he still has a debt of around £7,000 at about 30% APR and is struggling to pay it off, with monthly payments of less than £190.

At this rate, he will take another nine years to clear it and it'll cost him £13,500 in interest from this point, which is twice the outstanding debt. 

That wasn't the most shocking bit. 

He has been repaying this loan for ten years already. We can calculate that he started by borrowing around £7,500 and has paid off a mere £500 of debt, because you always pay more interest in the early years and repay less debt. Talking about interest, in the first ten years of the loan he could already have paid – hold onto your seats – about £20,000 in interest

The bottom line is that this poor man is looking at paying a total of around £35,000 in interest on a £7,500 debt over 19 years, all because of the slow payments he is making at a disgusting 30% APR. 

50 times the interest of a 5% loan

This is a very clear example of what high interest rates do to your wealth - and your future.

Compare his loan to borrowing £7,500 at 5% APR: with the same repayments of under £190 per month, the debt would be cleared in less than four years and would cost just £700 in interest.

Although 30% is six times higher than 5%, this man could pay 50 times as much interest, demonstrating that each extra point of interest increases the pounds you pay by considerably more than you think. 

Borrowing £7,500 at <£190 per month

Details

30% APR

5% APR

Total interest paid

Around £35,000

Around £700

Time taken to repay debt

Approximately 19 years

Less than four years

Borrow for fun? You're asking for trouble

The fun money he borrowed is now haunting him. Every life goal has been pushed back, and he will be poorer forever by tens of thousands of pounds. The debt is taking way too long to clear, meaning he will almost certainly have an emergency he can't cope with in that time. 

Indeed, this man and is family are now suffering such an emergency. One unexpected baby and two unfortunately reduced incomes later, and the family is now haemorrhaging about £200 per month. Roughly the amount of the debt repayments. 

It may seem obvious that, if he can switch to another cheaper loan or credit card, it would be a good idea to do so. However, this often isn't a debtor's best option, particularly if he has more than one debt and is struggling to make repayments. All his circumstances need to be taken into account. 

The first step

This family needs to take the decision to get its problem under control. I talked to them about what luxuries they're paying for. There aren't many, but it's ten years past time for having this discussion.

We weighed up the pros and cons of going on like this. If they continue to buy and enjoy now what they can't afford, they'll also have to keep trying to hide from the extreme stress of living in such a dangerous and spiralling situation.

We also considered the greater confidence, relief and self-esteem they'd get by bravely facing their problems. And how they'd be able to afford more luxuries over the course of their lives if they bit the bullet  now.

I was relieved that I talked them over. They're going to cut their entertainments to the absolute bare minimum number, meaning they won't pay for satellite or expensive mobile contracts, costly holidays or anything else. They're also in the process of moving somewhere cheaper. 

Step two

After this lightbulb moment of accepting that now is the time to take action, the next step is to lay out the situation clearly. 

They told me the debt is “about” £7,000 and they're now losing “roughly” £200 per month, and paying “something like” 30% APR. These wavy figures demonstrate how little they have faced their problems, which are probably worse than they realise. 

They need to get it down more accurately. Since they have no savings, they must be borrowing the £200 they're short every month from elsewhere, perhaps from an overdraft. They need to note down their total debts and all the interest rates they're paying. 

The best way to lay out your complete financial position is to draw up a statement of affairs

Step three

Their next step is to choose where to take their statement of affairs to get further advice. After we discussed their options, one of their top choices is social media of the oldest kind: an online debt discussion board. Here they can anonymously ask for help and support from debtors, former debtors and debt professionals.

Alternatively, the family will try National Debtline, which offers free phone or internet advice, tailored to your situation. This impartial debt advice service is another great choice, because it will help the family to ascertain the best way to get through its problem. I have heard only good things about this service after many interviews and much research into debt over the years. 

> Check out lovemoney.com's fantastic budgeting tool: MoneyTrack

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Comments (12)

  • richmoll
    Love rating 26
    richmoll said

    Some comments, firstly re:

    "Compound interest is not hard to understand and is taught at GCSE level"

    It may be taught but that does not mean it is learnt, recent press reports state 50% of adults have numeracy problems. I teach compound interest at University and many of my students struggle with it. Likewise many adults struggle to understand percentages, but these are the basic tools of finance so no wonder many people have problems. I wonder what is actually taught in finance at schools. Do you really get into the hard stuff like what is the monthly payment for a loan of £10,000 assuming interest at 6% and to be repaid over 10 years? Because if you don't do the numbers many people will still struggle to understand.

    Report on 07 March 2012  |  Love thisLove  0 loves
  • Neil Faulkner
    Love rating 32
    Neil Faulkner said

    "Why doesn't a friend pay the debt for him?" is a reasonable question, Ruthless Investor, even if the way you put it was unnecessary.

    I have read messages from thousands of debtors and interviewed debtors, former debtors and debt professionals, so I know very keenly about the various ways to deal with debt problems, including the option of a friend paying the entire debt off at full price.

    I won't go into the details of why I'm not helping the man in this story although I have the means, because it's not your business. However, here are just some reasons why paying off debt for friends or family isn't always appropriate:

    -- They might not want help and would rather deal with their problems themselves.

    -- There could be people more desperate for help, or it could be more cost effective to help more people for the same money.

    -- A good debt charity should, in almost all cases, offer a solution that is better all round.

    -- Helping family/friends pay off their debts can, in some circumstances, actually be a bad thing to do.

    Report on 13 March 2012  |  Love thisLove  0 loves

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