Albert Einstein once said that “those who understand interest earn it, those who don’t, pay it.“
I was shocked to learn that, for the first time since the relevant records began in 1987, the British public have moved from being net savers to net borrowers.
According to the Office for National Statistics, households have been building up more debt than savings for five quarters in a row, and for a full year for the first time.
And savings as a percentage of disposal income have also fallen to a record low, of just 4.9% in 2017 — worse than 1971’s previous low of 5.2%.
The turnaround is surely spurred by a combination of incomes falling in real terms, and inflation picking up after the Brexit vote. Interest rates are very low too, and that’s sure to be putting a lot of people off.
In such times, how can you avoid chronic debt problems? Here are three thoughts.
Keep an emergency fund
The charity StepChange has suggested that keeping an emergency fund of £1,000 would be enough to significantly reduce the scale of problem debt in the UK, and here at the Motley Fool that’s one of our key steps to financial security.
I’d recommend you keep the equivalent of at least a month’s salary in a savings account somewhere, and never touch it unless you’re faced with an emergency. You’d be a lot better off should your boiler unexpectedly give up the ghost than those folk you see in the TV ads calling up one of those payday loan companies which charge eye-watering interest rates.
And if you do need to dip into your emergency stash, make topping it up again your key financial priority afterwards.
Don’t spend on credit cards
The judicious use of credit cards can actually be beneficial. Usually, if you repay each month’s spending in its entirety within an interest-free period, you can effectively free up one month’s spending from your income for another purpose — like building up your emergency fund.
And it might sometimes seem worth paying a little interest if it allows you to bag a bargain that you’d otherwise have to miss. But even then, it’s still better to build up some savings first and use that next time there’s a big sale at your favourite store.
Spending beyond full monthly repayments can also be the start of a slippery slope, and it’s surprising how quickly the occasional spend can turn into a crippling debt burden. What if your debt does build up?
Pay it down, don’t switch it around
Balance-transfer cards are popular, allowing debt to be moved to a new card at a special offer rate. Sometimes there’s even a zero-interest period. But there can be hidden costs.
There’s typically an up-front fee for the transfer, which still might be worth paying. But there’s often a higher standard interest rate after your introductory offer, which could be onerous. There are cards charging 30% per year and more, and you don’t want to get stuck with one of those.
And don’t think you’ve solved your problem and relax, because you’ve only delayed it. Use the time to increase your payments and get some of the balance down.
And once that final penny of debt is paid off, you can start investing for long-term wealth.