Unfortunately, many people's finances have taken a hit during the COVID-19 pandemic and the true long-term effects on household wealth will take a while to become clear.
People in debt were more likely to run down savings in response to a fall as the pandemic struck last year, according to the Bank of England. Almost 9m people were forced to borrow more due to COVID-19, according to The Money Charity.
Managing your money has never been more important than in the pandemic era. Here are ten tips on how to cut down your debt and get back into the black.
Watch: Should I pay off debt or save money during the pandemic?
1. Cut out unnecessary spending
Often, we spend money without really thinking about it. How many times do you buy a coffee or subscribe to things that you do not even use? How many times do you splash out on a sale without realising you have actually spent more than you would have if the sale was not on?
Retailers want you to keep buying more because their motivation is profit, not your financial stability. Resist the temptation to say yes to things you don't need and establish your financial priorities so you do not exceed an appropriate budget.
Legendary investor and philanthropist Warren Buffett said it best: “Don’t save what is left after spending; spend what is left after saving.”
2. Open a savings account
Choosing whether to save or pay off debts depends on your financial situation.
"In an ideal world we recommend both, because what you don't want to do is repay your debt and then an emergency happens," says Louise Higham, a chartered financial planner and director at Tilney Smith and Williamson.
She recommends looking at what spare income you have and splitting it: 90% towards paying off debt and 10% towards a savings account. Interest on debt is usually higher than the interest on a savings account, hence why more money should go towards paying down debt, but you don't want to be left with no savings at all. Higham adds that is it good to have at least 12 months of expenses saved.
Individual savings accounts (ISAs) allow you to save more because the bank contributes to what you put in with tax-exempt interest. There are four main types: cash ISAs, stocks and shares ISAs, innovative finance ISAs and lifetime ISAs.
There are other types of savings accounts as well. Speak to your bank to find out more.
3. Avoid payday loans
Payday loans can seriously hurt your finances, because the astronomical interest will keep you perpetually paying it off.
Higham says that although the industry is more regulated now, payday loans should still be avoided. They can affect your credit score, especially if you take them out consistently, and this can make it harder to get mainstream loans such as mortgages when you are in better financial health.
"What that shows any potential lender is that you are not managing within your budget," Higham says.
More data is emerging about the way these loans are given to customers, many of whom are unaware of the true costs. Hidden fees often crop up when payments are late, on top of the interest. If you save as much as you can, you are less likely to need loans like these.
4. Avoid relying on credit, especially if you know you’ll be behind on a bill
Similar to the above, buying something with money you don't have is dangerous. Being behind on a credit card bill is a sure fire way to keep yourself in debt, so think twice about a purchase if what you are buying is not urgent.
Similarly, buy-now-pay-later schemes simply kick the can down the road. Think about what will happen if you can't pay later.
"Try, with credit cards, to overpay on the minimum payments so you can get it paid off quicker," Higham says.
"If you are going to use credit, make sure that you've got a clear structure in your mind that you're going to pay that off."
5. Regularly monitor your financial situation
Study your bank statements, receipts, and every record of what is going in and coming out of your account. If you have no financial awareness you will not be able to manage your money. It may be uncomfortable, but it is a necessary step. Knowing what's going in and out of your account helps keep you disciplined.
If the above advice is not enough and your situation is more serious, there are still other options.
6. Debt Respite Scheme
Also known as the Breathing Space Scheme, the Debt Respite Scheme gives you 60 days where no action can be enforced against you. No interest or other charges can be added to your debts in that time either. This gives you a chance to sort out your finances but you will still have to pay off your debts after the 60-day timer is up. The scheme is free if you apply yourself but a debt adviser may charge you.
7. Debt Management Plans
This is where you and your creditors agree on a plan to pay our debts, usually when:
You can only afford to pay creditors a small amount each month;
You have debt problems but will be able to make repayments in a few months.
Management plans can only be used to pay ‘unsecured’ debts, i.e. those not guaranteed against your property.
Arranging a plan with your creditors can be done by yourself or you can go through a licensed debt management company. But be aware, the second option comes with a fee and you will be making regular payments to the debt management company as well as your creditors.
You can get more information from Money Helper.
8. Debt relief orders (DRO)
A DRO will free you from your debts after a year and creditors will not be able to recover their money from you without permission from the courts. You may be eligible if you fall into the following categories:
Your debt is less than £30,000;
You have less than £75 a month in disposable income;
You have less than £2,000 worth of assets;
You do not own a vehicle worth at least £2,000;
You have lived or worked in England and Wales in the last 3 years;
You have not applied for a DRO within the last 6 years.
Your DRO is added to the Individual Insolvency Register and removed three months after the order ends. A DRO also stays on your credit record for 6 years. This is a public record.
9. Individual voluntary arrangements
Another way to pay back some or all of your debts is an individual voluntary arrangement. An insolvency practitioner works out what you can afford to repay and how long repayment lasts, based on details like your assets, debts, income and creditors.
The insolvency practitioner contacts your creditors and the IVA will start if creditors holding 75% of your debts agree to the plan. It would apply to all your creditors, including those who disagreed, and stops any of them taking action against you.
There is usually a set up fee and a handling fee each time you make payments so ensure you know how much it will cost before the practitioner acts for you.
The IVA can be cancelled by the insolvency practitioner if you do not keep up with repayments, and they can make you bankrupt.
The IVA will be added to the Individual Insolvency Register. It is removed three months after it ends.
10. Writing-off debt
As previously mentioned, unsecured debts can be written off, but you would have to pay back some of it. Go through your budget with your lender and a debt management consultant to see how much you can afford to repay.
To have all debts written off completely, you have to declare yourself bankrupt. This should be considered as a last resort as it can affect your job or future job prospects.
With all of the above options, Higham highlights the importance of doing thorough research and checking that any debt management consultants you speak to are regulated by the Financial Conduct Authority. Unregulated 'advisors' can give you the wrong advice and put you even deeper into debt.