Paying off debt explained
Being in debt can make you feel like you’re not moving forward. If it isn’t acknowledged or dealt with, it may also cause worry and stress, have a negative affect on your mental and physical well being, and it can also affect your savings goals, which might cause problems in the future. On this page, you’ll learn about the different types of debt and what the best way to clear debt might be for you.
Table of Contents
What are the different types of debt?
There are two different types of debt, known as secured and unsecured debt.
Secured debt means that a lender will require you to place property, or something of high value, as collateral in the event you can’t repay your debt. This is why it is called ‘secured’ debt. If you’re no longer able to repay your loan, the lender might be able to take possession of or force you to sell your collateral in order to pay off your debt.
The most common type of debt is unsecured debt. Unsecured debt includes overdrafts, payday loans, personal loans and credit cards. It doesn’t require collateral, just your promise to repay the loan. With an unsecured loan, you borrow money from a lender and make regular payments until it is paid in full. Unsecured debt typically has higher interest rates because of the lack of security, and charges should you fail to make a payment. Failing to make repayments could also adversely affect your credit rating, and may lead to insolvency or bankruptcy.
What’s the best way to pay off debt?
A good first step in paying off debt fast is to consider which of your debts is most expensive, by looking at how much you have left to repay and the interest rate. In most cases, the most expensive debt has the highest interest rate, and settling this type of debt first can provide more relief.
How can I clear my debt?
There are many ways to clear your debt*, but the most common approaches include consolidating debts and readjusting your budget.
You could readjust your household budget and create a new budget plan. This will help you to pay off your debt earlier, and allow you to more effectively track your spending and handle your finances. With an organised budget and a commitment to sacrificing luxuries or nice-to-haves, you might find you can free up more money than you thought possible. That way, you can allocate more of your monthly income to paying off the debt.
Debt consolidation means taking out a new loan to pay off existing debts. This might be the best way for you to pay debt if you have a loan or credit card with a high interest rate, and payments that you might be struggling to keep up with. You could apply for a loan to consolidate these debts and make your finances more manageable.
5 tips for paying off debt
1. Create a budget plan
A good first step to take, creating a budget plan allows you to accurately monitor your monthly income and expenses. It helps you understand where your money is going every month, and narrows down which expenses are essential and which can be eliminated. By eliminating any expenses that aren’t a necessity, you could free up money that can go towards paying off your debts.
2. Pay more than your minimum balance
To make a positive impact on your debt, it’s a good idea to pay more than the minimum payment requirements. If you find that you are financially able to do so, paying more off each month could mean that you pay off your debts faster, and you’ll pay less interest.
3. Pay in cash rather than by credit card
It’s easy to incur debt by spending on your credit card. Try to avoid this temptation so you’re not increasing your debt, and you may be able to gain more control over your finances and channel more funds into paying off your debt. If you can stop using your credit card, you may also find it easier to pay off existing credit card debt.
4. Sell unwanted items and cancel subscriptions
Selling unused or unwanted items could generate money that you can then use to pay off your debt. You might also find that unused subscriptions are draining your finances without you even realising. Cancelling these subscriptions could be a quick and easy way to free up more money to pay off your debts.
5. Remove your credit card information from online stores
If you often shop online, you may have saved your credit card information at an online store to make your transactions faster. You could avoid the temptation of online shopping by simply deleting your information and unsubscribing from any store emails.
If you’re in a lot of debt and you can no longer manage it, you may need to take a more advanced step, such as one of the following options. These ways of clearing debt are last resorts, and it’s best to come up with a plan that could help you pay off your debt fast, before you get to that stage.
Debt Management Plan
A debt management plan is an agreement between you and your creditors to pay off all of your debts. Usually, debt management plans are used when you can only afford to pay a small amount each month, or when you’re experiencing problems but will be able to make repayments within a few months. You can either arrange to do this yourself, or through a licensed debt management company on your behalf. It’s important to be aware of any fees, and not enter into an agreement before you know the details. While it might be more time-consuming, it’s often more cost-effective for you to make arrangements directly with your creditors rather than going through a management company.
Individual Voluntary Arrangement
An individual voluntary arrangement (IVA) is an agreement you reach with your creditors to pay part of or all of your debts. This requires you to make regular payments to an insolvency practitioner who will divide this money between your creditors.
An administration order may be the best option if you have a county court or High Court judgement against you that you can’t afford to pay. If you meet the eligibility requirements, you can make a monthly repayment to the court who will divide it between your creditors.
Debt Relief Order
Debt relief orders are another way to clear debt, providing you owe a lender less than £20,000, don’t have much spare income and don’t own your home. A debt relief order stipulates that creditors cannot recover their money without the court’s permission, and incurs a fee of £90. You may be discharged from your debts after 12 months if you are still unable to pay.
A bankruptcy order** may be your only option if you cannot pay off your debts. In order to pursue this process, you will have to make an application which is considered by an adjudicator, who will ultimately decide if you should be made bankrupt. During a 12-month period of bankruptcy, any non-essential assets may be used to pay your creditors. At the end of this period, most debts are written off.
Does being in debt affect my credit score?
Debt can affect your entire financial well being, including your credit score. If you miss a payment, for example, there’s a chance your lender may report it to the credit bureaus. If you carry high balances or are at or near your credit limit on your credit cards on a monthly basis, this may also negatively affect your credit score.
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