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

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. 

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