A Little Bit Richer

This series is brought to you by L&G, helping you build a future that's a little bit richer.

Iona: Hello, I'm Iona Bain and welcome along to A Little Bit Richer, brought to you by Legal & General. From credit cards to car finance and buy-now-pay-later, debt has quietly become a normal part of life for our generation. But just because its common doesn't mean it's easy to deal with or talk about. Whether you're just about keeping on top of repayments or starting to feel the pressure, living with and managing debt can be a struggle. Debt is a fact of life, something we all have to deal with, but hopefully we can do that without shame.

That's why I'm so pleased to be joined by an incredible woman who's done loads of work to help raise awareness of debt and the support available for those struggling with it. That's Claer Barrett. Claer is the consumer editor at The Financial Times, a columnist, broadcaster, and the force behind the FT's financial literacy and inclusion campaign. Welcome, Claer.

Claer: Thanks for having me, Iona.

Iona: Claer, how common is it for Millennials in the UK to live with debt? How has society's attitude towards debt changed over the years?

Claer Barrett: Well, debt is a fact of life. The reason for that is because life has become more expensive for subsequent generations. Before we go any further, let's just say if you have debt, whether it's good debt or bad debt, it's not a personal failing. This is something that is affecting all of us. But also, it's not something that eating fewer avocados can necessarily resolve.

There are all kinds of reasons for that. Salaries stagnating, particularly for graduates who have got ever- higher amounts of student loan debt that they need to repay coming off their salaries every month. So much so, that there's a new term that I've become aware of. Negative wealth. Have you ever heard of this?

Iona: I can't say I have.

Claer: Okay. Negative wealth is where your debts, which include student loans, but also overdrafts, credit cards, any buy- now- pay- later add up to more than the value of your assets. Things that you own that are worth money, like a car or a property, say. So much so, around one- third of 25-to- 34- year- olds in the UK, it's said, are in negative wealth.

Now this is a survey by the Fairness Foundation, so this is proper research. The biggest reason why one group of people might be in negative wealth compared to positive wealth is, guess what? Being on the property ladder. If you've managed to get on the property ladder, you will have an asset. But for those of us that didn't have that helping hand, be paying extortionate rents in the private sector. The big takeaway for me here is that education and knowledge about debt so that we can minimize the wrong type of debt and be aware of the problems that we can get into if we take out too much debt is embedded in us at an early age because that is going to make the biggest difference for when the negative will hopefully turn positive later in life.

Iona: Give us a sense of the kinds of debts that young people are leaning on in order to get through life?

Claer: Well, people talk about good debts and bad debts. Let's start with the good. The most obvious example is probably student loans and mortgages. This is why we need to understand how debt works, how things like credit scores affect how much money we can borrow in the future. It's those forms of so- called bad debts that could put you down the rankings in terms of your credit score. Things like credit cards, if not managed well.

Things like buy- now- pay- later. If you take out too many, then you're going to have to rely on credit cards or your overdraft to pay the bills, because overdraft is typically 40% interest annually, credit cards typically 20% interest annually. But one- in- five people in the UK have an impaired credit score, which mean if they want to borrow using a credit card, it's even more expensive. Typically, an interest rate per year of around 40 or even 50 percent if you want to borrow money.

There's some common forms of bad debt and bad practices managing debt. It's often unfortunately, Iona, young people who don't understand what they're getting into who make those mistakes. Then they can hang around and blight your credit file for six or seven years.

Iona: Well, let's get into why that can turn into such a problem for young people further down the line. Just explain what your credit score is and what it's based on?

Claer: Basically, your credit score is an indication that lenders will look at at how creditworthy you are. If I were to lend you money, would you pay it back on time and would you make those repayments regularly? Because if you can, then I'll be more likely to reward you with a lower rate of interest. Whereas somebody who has paid bills late or has borrowed more than they can afford, has got into difficulty paying that money back, you can see that they've had problems in the past because lenders can look through your credit file, and they might charge you then a higher rate of interest if they're going to let you borrow.

Or they might decide not to lend to you at all. Let's say you apply for a credit card. The credit card company says, " Here you go, here's a card. You've got a credit balance of £ 10,000." Technically, you could take that card, you could go out, and you could buy something for £ 10,000. But the reason why you shouldn't do that is because of something called credit utilisation. Now, this is really big issue with people's credit scores. If you borrow more than 30% of what your credit limit is, that's not going to trouble the lender too much. But if you were to borrow over 50% of the limit they think, "

Oh, they're utilising quite a lot of credit. This is making them a higher risk." If they want to borrow any more money maybe further down the line for a mortgage, all of those repayments are going to eat away into their monthly pay packets. It's going to make their affordability look much worse if they're applying for a bigger loan because more of their money is going towards servicing their debts.

That could also start to pull down your credit scores. If you've got a really high rate of interest on a credit card, commonly 20%, often much higher, over time, the magic of compounding is going to work against you. The amount of time it will take you to pay off that balance and the amount of interest that you'll repay on top of the money that you've actually borrowed could really surprise you. If you know that before you took out the credit card, would you have taken it out?

Iona: It feels like a hidden trap, whereby if you don't know that you're not really supposed to spend over 50% of the credit available to you, and yet you're punished for it later, I would imagine a lot of young people would say, " That's really unfair." If people are feeling like they have to take our a credit card in order to improve their credit score, but don't really want to for all the reasons we've discussed, what are the alternatives?

Claer: People think that it's going to boost my credit score if I do this, it can actually end up getting people into deeper financial doo- doo because they can end up spending more money and have a bigger debt to repay and affect their affordability levels going forward. I would say go to your credit report, check first of all that there aren't any mistakes on there that need to be corrected.

But Experian, one of the credit file people, they offer a service whereby with open banking, you can share your details with them. They can count regular payments that you're making towards household bills, which could include paying your rent on time, paying our council tax on time that could boost your score by as much by 100 points just by linking up your data.

Iona: It's just about getting the basics right, that'll do an awful lot for your credit score?

Claer: Absolutely. Then when you do come to apply for a mortgage, going through a mortgage broker who will do a detailed breakdown of your outgoings. The crucial thing that mortgage lenders are looking at is affordability. How much money do you have left at the end of month after meeting your other commitments? Of course, those commitments include debt repayments.

Student loans are a factor of that. But if you've got a big credit card balance, even if it's on a naught percent interest, that's hanging around you. They can see eventually you're going to have to pay that off and that's the sort of thing that could count against you when you come to apply for more credit. It's a two- way street.

Iona: How can people distinguish between good and bad debt? We've talked about some examples, but what are the key questions that people need to ask themselves when they're taking out debt in order to make sure that they're going to use it in a responsible way?

Claer: Well, I think if you're taking out any form of debt to pay off another debt, that is a red flag. You should be thinking to yourself, " Hang on a minute. Are things getting out of control here?"

Iona: What about buy- now- pay- later? That's grown in popularity massively, but what are the risks with that?

Claer: Okay. Buy- now- pay- later, the big attraction of it of course is that the payments are interest- free and they can be split over three months. Frankly, if you're on a tight budget, that could be a godsend rather than paying 20%, 40% or more to borrow money on a credit card.

But let's step back a bit and think about how the business model of buy- now- pay- later actually works. Why is it that they don't charge us interest? How, therefore, do these gigantic businesses make money? The answer is the retailers pay them. If a retailer offers buy- now- pay- later on its website, it knows it will sell more stuff. We will feel like we've been given magic permission to spend more money. We might have bought a pair of jeans, but now we know that we can pay in three. Then we'll buy a pair of jeans, a top, and a pair of shoes. It can make us spend more.

Iona: Spend more than we necessarily would have wanted to.

Claer: At the moment, we have to self- regulate. A thrifty tip that I've used for years is whenever I find myself doom- scrolling online, putting items into the basket, I just leave them there for 24 hours. The amount of times I think, 24 hours later, " Actually, I've got a top exactly like that in my wardrobe already." Or, better still, I can find one on vintage. Better for the planet, better for your pocket. But the amount of psychology that these websites, the lifestyle they're selling, it's very, very hard to resist.

Iona: It's about building up that awareness of how the business models of credit card providers and buy- now- pay- later providers operate so that we can then make informed decisions.

Claer: Absolutely, Iona.

Iona: What are some practical steps that people can take to get on top of their debt repayments and reduce their debt over time?

Claer: I think the biggest thing is the bigger picture. Now, a lot of the time, people lose track of how much debt they've actually got because it's spread across multiple cards, overdrafts, different accounts, different sources of debt that they're frantically trying to keep on top of.

I think facing up to it and setting out what you've got where, but also having a bigger think about how has that debt been created. How has it built up? What have you actually spent the money on? Looking back at your statements will give you an idea, but often it's the cost of the interest which is the biggest factor in there pushing up the payments. We talk about often two methods for clearing debts, the avalanche method and the snowball method. Briefly, the avalanche method is listing all your debts, working out which one has got the most expensive interest rate. There will be one on there that's quite killer. You say, " Okay, I'm going to prioritize paying off that debt. I'll pay the minimum repayment on all of the others so they're cheaper, lower interest rates.

But the one that's got the real sky- high interest rate, it's in my interest to clear that the fastest." I'm going to avalanche any spare money I've got into killing that card. The other method, the snowball method, is that you target the smallest debt first. You might think, " Okay, well what's the point in doing that?" But psychologically, if you can say, " I've now cleared that store card, that's gone," that could give you the momentum to then go on and tackle the next one.

Maybe you do a snowball first, and then you do an avalanche. But the key with all of these things is get rid of the credit card when you've paid it off. All too often, I see people clearing debts on cards, they keep the card open. That's why I said look at why those debts built up in the first place, because whatever habit or problem that was caused for you to build this up in the first place, if you haven't closed off the card, then it's easy sadly for that to build up once again.

Iona: Then you're right back to square one.

Claer: Exactly.

Iona: Which you don't want. What can someone do if they already have debt issues, they feel that that debt is getting out of control, what solutions or organizations can they turn to?

Claer: Okay. If you are listening to this podcast and you have even a glimmer of a feeling that you might benefit from speaking to somebody about your debts, maybe you don't know how much they add up to. That's quite common, denial. Thinking, " Right, I'm not going to look at this. They're still saying I can borrow. I think I might borrow more money to pay off that card." Or you've had debt that's been hanging around for a long time that you're only paying off the minimum payment on so the interest costs, again, are getting higher and higher.

If you find that the value of your debt isn't really falling anymore, it seems to be growing, these are all signs, take it from me, that you would benefit from talking to a debt charity. Now, most people would say, " I don't need help from a charity! I'm not a charity case." But the reason why you should is, number one, most of the funding for debt charities comes from the finance industry.

Iona: Ah.

Claer: Because they have a legal and regulatory obligation to help customers who are in problem debt. A certain percentage of customers will fall into problem debt, no matter how big the warnings are. The second big fact is that it is never too early to ask for help if you're worried about the debts you're in. As human beings, we're hard- wired to try and sort these problems out for ourselves.

Typically, we'll look for solutions online. But the problem with that is is that the kind of things that come up in internet search engines, the sponsored ads are often organizations that profit from selling people in problem debt a particular kind of solution.

Iona: Like a debt management plan?

Claer: Exactly. An IVA is another one, a form of insolvency where you pay a fee to enter into an arrangement. Now, that might be the right solution for you. But if you're going to a provider who only offers that as a solution, something else including a debt relief order where they can wipe off some of your debt, you never have to pay them back, you're not going to find out about those kinds of solutions until you speak to an independent debt charity who can work out what the best solution is for you. It doesn't have a motivation to put you in one kind of plan or another.

When you've done that, you've got a much better chance of getting out of debt and getting your finances back on track. The final tip I'd say, you don't have to talk to a debt charity on the phone. A lot of people find, because there's a shame attached to debt, wrongly attached to being in debt, sometimes people just can't face having a conversation about it. But all of the big debt charities tend to do web chat now, which I think is a fantastic innovation.

I would say Step Change, they're one of the biggest debt charities in Britain. Citizen's Advice, particularly good if you've got problems with bills that you can't pay, things like council tax which can get quite nasty very quickly. Then if you've got any sort of intermingling of business debts and personal debts, maybe you're self- employed, Business Debt Line are the place to go. All of these places are free to contact and the advice that they give you is free.

Iona: That's really good to know that you could even do this on your lunch break at work. Or when you get home from work and you've got the TV on, you could just drop them a line, reach out. Claer, what are the three tips that you would give to someone listening who wants to reduce their debt and make sure that they are debt smart in the future?

Claer: I would say just have a great awareness generally of your finances, what's coming in, what's going out. You don't need to sit down and do a formal budget. There are lots of apps nowadays, like Snoop and Emma, that use open banking to go through your income and expenditure and make suggestions. But just be aware of what you've got.

And also, the interest rates that you're paying on some of these debts and being super on top of when repayments for things like buy- now- pay- later are due. If you don't meet them on time, you'll get a fine. It might be interest- free, but that is going to cost you money ultimately. Finally, I would say go online. There are so many good free resources online from the main debt charities themselves. Step Change, Citizen's Advice, and also Business Debt Line if you're self- employed.

There's a wealth of information out there. We've also go my charity that I'm a trustee of, FLIC, the Financial Literacy and Inclusion Campaign. We've made a free guide to managing debt containing all kinds of help, resources, links to further sources of support and information. I believe, Iona, that you have helpfully attached it to the show notes of today's episode.

Iona: Well, there we go. A good first step for people to check out. Wonderful. Thank you so much, Claer.

Claer: Thank you for having me.

Iona: Thank you so much, Claer, some really great advice there. Next time, friend of the show and financial advisor Emmanuel Asuquo will be here to help us put good friction in our finances. This podcast is brought to you by L&G. You can keep up with the show on YouTube, TikTok, and Instagram @legalandgeneral. I'd love it if you could follow the podcast, leave us a review, and help others get a little bit richer, too. Thanks for listening. Until next time, see you soon.