UK society is addicted to debt. Latest figures (May 2012) indicate that on average UK families each have around £7,891 of unsecured debt. Collectively we owe £208 billion in unsecured debt, in addition to mortgage debt of £1.252 trillion (or £1,252 billion for those who struggle to process a billion, never mind a trillion). In the US, total personal debt is estimated at $10.9 (£7.03) trillion, which works out to be a lower per capita figure than in the UK.
Clearly, we live in difficult economic times and I have personal experience of what it is to have little option but to be in debt, and for far more than the current average of £7,891. Thankfully that is in the past now and those debts have been repaid.
For families who through no fault of their own find themselves in dire straits, taking on debt is how we make it through lean years. I have great empathy for and personal solidarity with such folk.
Nonetheless, we also need to confront the consumerism that is part of our culture, which invites us to spend what we don’t have. Our desire for instant gratification and need to keep up with the Kardashians (the Joneses are so last millennium) as well as the advertising encouraging us to take on unnecessary debts all need to be challenged.
What are the moral issues raised when we spend money we don’t have, on things we can’t afford, so that we have what we don’t need, to give the impression to people we don’t know that we are less impoverished than we really are?
So whatever happened to saving up and working towards what we want? What happened to saying, ‘No I can’t afford that now but I could afford it in 3 years time?’ It is this idea that some things take time that the ethos of a 5-year project tries to emphasise.
I should declare that I am extremely debt averse. So I accept that mine is a particularly jaundiced view on debt. I deeply dislike the experience of being in debt. Some people can sleep easy despite being in debt. I have been known to be awake at night thinking about other people’s debts!
I can cope with a short-term debt that I choose to have, because it suits my financial goals, and which I could pay off any time I liked.
Similarly, I can cope with a debt that pays for an important asset, say a mortgage, not least because the asset could be sold to liquidate the debt, but also because that kind of asset should appreciate in value. In a best case scenario the future value of the asset exceeds the amount borrowed plus interest paid.
Best of all I could cope with a debt on which I pay no interest. Because of inflation, future money has lower buying power than current money. In simple terms, £100 will buy more today than it will in 5 years time. So given a choice, it is good financial sense to pay that £100 later rather than now if there were no interest penalty.
What I can’t cope with is a debt to which I feel shackled, one which charges me interest, claims first dibs upon my already overstretched pay cheque, or prevents me from doing other things I might wish to do.
Moreover, debt makes no sense in the long term. Let’s say you wish to buy a car for £12K. You have £2K in savings and intend to borrow the remaining £10K over 4 years. One of the best loan rates currently available is 5.9% from Sainsbury’s’ Bank. They offer a £10K loan repaid in 48 payments of £235.93 per month for a total repayment of £11,324.64. So the £12K car would, in fact, cost you £13,325 and take 4 years to pay for.
This is not a bad deal. In fact, it is one of the best on the market. Moreover, if you needed a car urgently a loan would mean that you could be on the road asap. But what if you decided you didn’t want to borrow? What if you already had a car and continued to live with your old clunker for the next few years whilst putting the money you would have paid in loan payments into a tax-free saving account?
So assume you had a tax free ISA from Santander paying 3.3%, one of the best rates available right now. You already have £2K in your ISA and you begin to make a regular savings deposit of £235 each month.
At the end of 4 years you will have a total of £13,280. The best bit is rather than paying the bank £1325 in interest they would have paid interest to you of £1,058. So combining the interest you have avoided with the interest you have earned means you would be better off by a total of £2,383!
That sum, the equivalent of £596 per year could easily finance a decent wardrobe-building project all by itself. All this is achieved by taking a longer-term view and saving instead of borrowing. Note that the monthly commitment of £235 over 4 years is exactly the same.
You will have reached the £12K target at around 3½ years so the extra £1,280 could be used for insurance or road tax (or furry dice). Alternatively, if over the 4-year period there were months which were financially stretched you would have the flexibility to skip a monthly deposit or two or to pay in less than £235 once or twice and still hit your £12K savings target in under 4 years.
Admittedly, there are drawbacks to this latter approach. First, you have to wait at least 3½ years before you get the car instead of getting it immediately and paying for it whilst you use it. Second, the cost of inflation will erode the future buying power of your savings. If we assume only 2% annual inflation, the car which had been £12K will, 4 years later, have risen in price to £13K.
Despite these potential drawbacks, given the choice I prefer the latter approach. In fact my other 5-year project (which will probably take longer than 5 years) is to build up a car replacement fund so that I don’t need to borrow when our current car (11 years old and counting) is finally replaced.
This is because I take the long-term view that it makes no sense to borrow if you can avoid it, to pay interest rather than receive it. Saving rather than borrowing also offers greater flexibility if your situation changes, as it is easier to adjust savings deposits than loan payments.
So if you have some debts piling up, whether larger or small perhaps your first 5-year project should be to deal with those. Once that project is up and running perhaps you then can begin building a gentleman’s wardrobe.
So what do you think?