Money mensch: Being prudent may not be enough
I once met a man with £80,000 in savings earning less than one per cent interest, while he had £80,000 outstanding on his mortgage. Yet he said he was good with money.
Like many, he thought being thrifty was enough. In fact, he even boasted how he didn’t let the little lady near the books. Both parties in a relationship should know the details of the finances, because death and divorce happen. The real problem is the fact that you need to learn to understand how money products work.
As many are doubtless taught at the David Brent school of management training: “if you assume — it makes an ass of you and me!” So here are some wealth warnings based on things I have come across during my TV money makeovers.
Pay off your debts before saving
With £80,000 mortgage debt at over 6 per cent interest, switching to a better deal would have cut £100 a month off this older family man’s costs. As his mortgage had been untouched for years, it wasn’t going to prove difficult.
You need to understand how money products work
The irony was he had savings for a similar amount with the same bank. The savings documents languished in a draw and showed the interest was sub-1 per cent — and that was prior to the scything interest cuts of recent years. In other words, he lent his bank £80k at 1 per cent by saving and it lent him back the same cash at 6 per cent in the form of a mortgage.
The family cleared the mortgage with savings and was £5,000 a year better off. They reduced their costs by nearly £50,000 by the time the loan was due to be cleared.
The wider rule: Pay off your debts before saving. The cost of debt almost always dwarfs the amount earned from savings. So clearing debts is normally the most efficient, risk-free thing you can do with your cash (see www.moneysavingexpert.com/repaymortgage).
Make the most of your credit
As often happens in the run up to a money makeover, the family knew the cameras were due and started to try to sort out their own finances. It is a bit like people who dust and polish a house because they know the cleaner’s coming.
In this case, she had over £10,000 of outstanding loans and credit-card debt and applied for a new, though sadly not market leading, 0 per cent balance transfer credit card.
Yet the card had a £6,000 credit limit, and they’d only shoved £2,000 on it. She had failed to realise could move other card debts to it too. As they had a host of other cards at 15 percent-plus interest, filling this up would save over £600 a year.
The wider rule: Before making new card applications, utilise your existing credit more efficiently. This helps to protect your credit score and can mean savings even if you get rejected for new credit.
To do it, check all your cards’ interest charges and find out if there is room on your credit limits. Call up each provider and ask: “Will you give me a special cheap rate if I move debts from other cards to you?” You will be surprised how often they say yes, MBNA and Barclaycard especially. Then shift the debt to where the interest rate is lowest.
Even if you are not offered a special rate, shift the debt from the more expensive card to fill up the cheapest card’s credit limit. If you still need cheaper credit, apply for a new deal to shift all remaining expensive debts.
Take time over home insurance
In the days of house price boom, each year one man proudly changed the ever-escalating house valuation on his insurance form (the same man as who had the savings and mortgage) every time he was due to renew. When I arrived, his premium was well over £1k a year.
Yet it was completely wrong. For buildings cover, it is a property’s rebuild value that counts. This is literally the amount it would cost to rebuild a property from scratch if it is destroyed, usually substantially less than the market value. In fact, even with his own, expensive, insurer, reinsuring at the rebuild rate slashed the cost to £250 a year.
The wider rule: Know what you need to cover and take time to value it correctly. Under covering is just as damaging as over covering. For example, if you have £30,000 worth of contents, but only cover £10,000, do not assume it will be fine.
Imagine £1,000 damage to your kitchen. While that is within your cover limit, the insurer may check your value of contents, then only pay out in proportion to what you have covered, in this example a third of the value of the damage.
Yet it is possible to get adequately covered home insurance super cheaply. The best route is combine comparison sites and check if you can get hidden cashback on top.
The record result using this system is actually being PAID over £60 to get home insurance, as the cashback was higher than the policy cost.
Don’t hide debts from yourself
Families in debt often try and hide it. The classic way to do this is to periodically shove credit card and loan debts onto a mortgage and then consider it vanished.
In one worrying case, a family who had raised concern about £20,000 debts, equivalent to nearly a year of their after tax income, told me it had taken around a decade to build up.
That seemed a slow burn rate considering their spending habits. Only later in the day did it turn out they had remortgaged three or four times during that period to clear debts to a total of over £100,000. So rather than a £2,000 annual overspend, it was far closer to £12,000.
The wider rule: Persistent borrowing is a vicious symptom of overspending.
If you have debt and it’s not from a one-off planned, budgeted piece of borrowing, then it is almost certain you are spending more than you earn and that’s a critical danger signal.
Keep it up and you risk a debt spiral, borrowing even more to enable you to continue your existing lifestyle and repay other debts. The end result is there is nothing left.
The most important thing to do is a hardcore budget.
This means looking far beyond a typical month’s expenditure, that misses things like the daily coffee, weekly shop, annual holidays or changing car every five years.
Only by doing it that way can you truly see where you stand financially and how much you need to restrain your spending.
To help, I’ve a free automatic tool at www.moneysavingexpert.com/budgeting. Enter in the details of your situation and it instantly calculates whether you’re overspending or not.