Debt can be accumulated on credit cards, personal loans, mortgages, and overdrafts. These borrowing options aren’t necessarily a bad thing to have. A mortgage helps people to own their own home, which can then also be an excellent long-term investment. Loans, credit cards and overdrafts also serve a purpose and we’ve come a long way from the ‘never a lender nor a borrower be’ ethos that prevailed during our grandparents’ time.
Debt is something, however, that needs to be effectively managed, through regular payments. This can become more complicated where an individual has more than one type of debt. When in that position, it will become important to prioritise your debt payments. There are three main factors that should be considered when deciding on the prioritisation order and these are:
1. What the respective interest rates are.
2. Whether there are any potential related charges.
3. What teh impact may be upon your ongoing credit score.
Based upon these criteria, the order that you should usually prioritise your debt payments is as follows:
1. Unauthorised overdraft debt:
An unauthorised overdraft is where your balance either goes below zero where you have no agreed overdraft facility, or else where it drops below a previously agreed authorised overdraft limit. Unauthorised overdrafts are extremely bad because they usually come with an astronomical interest rate, hefty bank fees, and they leave a black mark on your credit score. The fees that you incur aren’t just one off either. Every month that you stay in excess, you will incur more fees and every time that a transaction is put through or rejected on your account, you will likely incur additional paid referral or unpaid items fees.
Your objective, then, should be to lose your unauthorised overdraft immediately. You may want to speak to your bank about extending your authorised overdraft limit, to reduce the likelihood of you finding yourself in the same position again.
2. Credit card debt:
The real danger with credit cards is where you get to the position where you’re not paying them off in full each month. When this happens, you will start to pay interest on top of the amount that you have borrowed. It can get to the stage where an individual is struggling just to service the monthly interest amounts and are not able to even contemplate paying off the capital amount.
Failure to make a monthly payment may also result in fees and will show on your credit report. Unlike unauthorised overdrafts, however, a credit card is not seen (from a credit score perspective) as a bad thing in itself. If you manage a credit card prudently, it can be a useful tool and can actually help your credit score. Your goals though should be to pay off your debt in full every month and to try to limit the amount that you’re spending on credit cards.
3. Personal Loans:
Loans have lower interest rates, in general, than credit cards. They also tend to have a structured repayment schedule so that you know exactly how much you need to repay each month, with the payment coming off by direct debit. However, failure to make a monthly payment (as with a credit card) will result in a black mark against your credit score and may result in fees being charged.
A mortgage is a secured loan, which means that if you fail to repay it, then ultimately the lender has the right to claim your property. It’s therefore crucial that you make the monthly payments. For the purposes of this article, however, I’m assuming that we’re talking about prioritisation where you are considering paying extra into your mortgage, on top of the standard monthly payment. Repaying your mortgage early is certainly a valuable goal but you need a starting point of being free of unauthorised overdraft, credit card and personal loan debt.
The reason for this is that mortgage rates tend to be lower than these other debt types and (assuming that you are making your standard payments) don’t accrue additional charges or cause damage to your credit score.
5. Authorised overdraft
Authorised overdrafts tend to have lower interest rates than unauthorised overdrafts and don’t incur fees. They are a buffer zone against going into an unauthorised position. However, there is a danger of considering them to be an extension to your monthly income. They are not and you should endeavour to operate without needing to dip into them too regularly.
This is a general guide and the best prioritisation order may vary depending upon your individual circumstances and the interest rates that apply on your debt types. If in doubt, then it may be worth getting guidance from a financial adviser. However, provided that due consideration is given to their repayment, then some of these borrowing options can be used effectively to make your life more easy.