In response to the cost of living crisis, the Bank of England (BoE) last week raised interest rates to as high as 1.25%, with the rate expected to rise further throughout the year . The increase then has a ripple effect on the interest rates set for personal loans, overdrafts and credit cards. As people turn to borrowing to help weather the cost of living crisis, many are at risk of getting caught in the ‘debt trap’. This is a situation where a person is forced to take out new loans in order to pay off their existing debts. This can happen if a person spends more than they earn, but can happen if unexpected bills come up, like a broken washing machine or car maintenance.
David Hendry, director of marketing at Freedom Finance, explains that personal loans have been generally popular as they have been described as a “relatively cheap” way to borrow as they “generally” have lower interest rates than credit cards and overdrafts.
However, with interest rates set to rise, Mr Hendry says it is ‘essential’ that people consider their situation carefully before taking out loans.
If loans have been taken out, people need to take a number of steps to improve their financial situation, which can either help reduce the need to borrow or make it easier and cheaper to manage their loans.
If a person has existing debt, especially with multiple loans or credit cards, the first step is to determine exactly how much has been borrowed.
Mr Hendry suggests that people make a list of all their debts, whether credit cards, store cards, unsecured and secured loans, overdrafts and mortgages. In addition to the amounts owed, a person should also note the interest rates and the lender each debt is with. People should then update this list regularly to keep track of their debts.
Mr Hendry adds that it will also help if people speak to their lenders as they may ask about some of these details, so it is good to be prepared for this conversation.
Once this has been done, people can also shop around for a cheaper loan to switch to. If a person is currently paying interest on loans, credit cards, or an overdraft, switching to a cheaper loan could lower their monthly repayments, making them more manageable.
Mr Hendry added that a person may be able to access a lower interest rate, which could lead to a reduction in overall debt.
The next step is to “not suffer in silence” because missing a monthly payment will only have a negative effect on a person’s credit card rating.
Mr Hendry said: “If you think you cannot pay, talk to your lender immediately, ideally before you miss the payment. You may be able to come to an agreement with your lender that makes your repayments affordable.
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Debt advice charities such as StepChange, Citizens Advice or National Debtline can offer free, unbiased advice and guidance to those struggling to manage their debts.
After talking to a lender and determining what they can afford, Mr Hendry also added that people can possibly consolidate their multiple expenses into one with a debt consolidation loan.
This allows a person to pay off all of their existing loans in one payment each month, rather than multiple payments on different days.
With debt consolidation, Freedom Finance added: “It should be borne in mind that if you spread your debt over a longer term to reduce your monthly repayments, you may end up paying more interest overall.
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“So before you proceed, you’ll need to consider whether it’s better for you to pay off your debt faster and pay less interest, or to make your monthly repayments more manageable by spreading them out over a longer period of time.”
After that, Hendry strongly recommends that people make a monthly spending budget.
He said: “A good tip for avoiding overspending and minimizing your need for borrowing is to create a budget. A budget can help you visualize all of your expenses so you can determine where savings can be made.
Having a budget can then allow a person to plan their spending on other expenses such as food, housing payments, and transportation costs.
People can then use “thrifty” tips and advice from experts like money-saving expert Martin Lewis and British writer Jack Monroe to reduce their spending in these areas.
For people who haven’t gotten a loan but think they might need one in the future, Hendry says the most important steps now are to improve their credit rating and open an account. savings.
He explains, “Your credit score is important, really important because it plays a role in determining the rate you get when you apply for a loan, a mortgage, a credit card.”
Ways to improve a person’s credit score include registering to vote and checking to see if your credit report contains errors.
When comparing rates, people should also be wary of sending too many inquiries to lenders, as this may indicate that a person is struggling to make money.
Mr. Hendry also recommends that a person set up a savings account because making regular payments into the savings account, even very small ones, signals to a lender that a person is taking care of their finances.