BOD004: How Do I Get Out Of Debt?

0:00People say like, I was in X amount of debt and through this. I get emotional when they tell me that they've pulled themselves out of it. I'm like, good for you. It does. Your car breaks and then you've got the toilet blocks and you've got to pay someone to get that in and then it's like, oh crap, I can't afford it.

0:15Pete:It seems to compound one thing on top of the other. If you are prepared, it seems to happen less often. Hi and welcome to the Bank of Dad podcast. I'm Kate and this is my dad Pete. Hello. And we're here to share the money lessons we were never taught at school. No judgement, no jargon, just real talk about how to handle your money. Well done, Kate, you got through that intro first time. Yeah, yeah. It's not a bad start. It's a minimum of three normally, isn't it? What are we talking about today? Well, last week we talked about budgeting. Mm-hmm. You know, helping make your paycheck last. Yep. And you last the whole month without substituting joy.

0:53Whereas this week, it's not a lovely topic, but it's a really important one.

0:57Pete:Super important. Debt. Yep. Part of many of our lives. Yep. Most people's lives. What it is. Is it good? Is it bad? Yeah. How do we get out of it? All of that we're going to cover. Lots to cover. Which I think is important to mention again. No judgment. Really important, I think, especially this week. Yeah. Yeah. So, yeah, you're right. We talked about spending. We talked about being intentional last time. very often debt is the result of not doing that and again no judgement where you know we're not born knowing how to drive a car neither are we born knowing how to handle money no this is what this is here for not born with the knowledge to learn Pythagoras but we learned that in school yep yeah super useful well it is for some people if you're a mechanical engineer or whatever so when you're in mechanical engineering school that's when you can learn it But before we get into debt, how it works, how to get out of it, whether it's good or bad, all that sort of stuff, we need to cover our segment, which we laughably call Wanky Word of the Week.

2:01Pete:Again, still no intro music. I'm sure we'll work on that before too long. What is this week's Wanky Word of the Week, Kate? This week, I have chosen the word emergency fund for Wanky Word of the Week. Yeah. So... What is it? Define. Your emergency fund is a fund of money that you have set aside for emergencies. You know, it's a good job you're here. It is. Time well spent. Okay. Look, life has a tendency to throw things at us. And if we don't have some kind of buffer between us and the world, the end result is usually debt. So if we are living paycheck to paycheck, the car fails its MOT, or it suddenly needs two new tires, where's that money come from?

2:44Pete:For many people, the answer is credit card, overdraft. Loan. Somebody else's money. Yeah, I need to get a loan. Even if it's a loan from family, right? Still debt. Yeah. And so your emergency fund is basically just a pot of money set aside so that you don't have to borrow for the unexpected. Cool. Makes sense? Makes sense, I think. Straightforward enough. Brilliant. Right, okay. Let's get into debt. This is such a big subject. So we need to try and be concise, but do the job right. Yeah. And again, no judgment, of course. Have we said that? There's no judgment. Don't feel, if you feel judged, that's on you now.

3:19Pete:That's on you, there's nothing to do with us. All right, we've said it. Okay, so I have heard the phrase good debt when researching this. I would like to know if that even is a thing. Because when I hear debt, I like see spinning sirens and flashing red lights. That's years of conditioning from me. Yeah, yeah. All right, so can debt be good? So yes, there is good debt and there is bad debt. Okay. The way to tell between the two is quite simple. The interest you pay on the debt and what you buy with it. So, good debt is generally low interest. It doesn't cost you a lot to have that debt. And it's used to buy stuff that goes up in value.

3:59So, like a house.

4:00Pete:So, a mortgage is a debt, right? So, you owe somebody money to buy a house. But because the house generally will go up in value, not always the way, but almost always. If you do any amount of work on it. Well, and generally speaking, mortgage interest is low. Okay. Right? That would be a good debt. There is an argument that student loans are good debts. A little bit less tangible, though. Because, relatively speaking, the interest is low, compared to, like, credit cards or store cards or payday loans. We'll get to that in a minute. And there's also quite... Sorry, no, carry on. And it buys you an education, which some might argue might give you better job prospects.

4:39It also... student loans specifically, there's quite a lot of ways. It's quite gentle with how you have to pay it back in the UK. Yes, it is.

4:46Pete:We'll probably do an episode on student loans. It's not really a loan in the classic sense, but it is a debt, right? So that's the other example I'd generally use, but a mortgage is a better one. So it's low interest and it's used to buy something that goes up. So bad debt would be... Is the flip. Yeah, so it's high interest. And used to buy stuff that goes down in value. so like if you buy a tv on klarna right or you don't like i'd well you know don't get sued but i don't like buy now pay later no yeah um so you know it's not just klarna others are available yeah but i don't like any of them it's the mentality it's the it's just yeah so or if you go into overdraft or you put that on a credit card yeah a tv the second you get it out of the box is basically worthless isn't it yeah because probably 20 minutes it's going to be a brand new one anyway the newest model and yeah exactly and these things are they're they're so cheap now i mean you know i remember when tvs were like as deep as they are wide right whereas obviously you know and a flat screen tv was like a wow it was an innovation right so electronics are commodities now they they're relatively cheap based when you think about what they can do right and so if you're borrowing on a credit card to buy a telly you're paying a lot of interest unless you pay the credit card off straight away that's different but if you're saying I want a really really nice telly and I'm going to pay 700 quid for it and you put it on a credit card and it takes you a year to pay it off by the time you've paid it off your TV's less than worthless and you've spent a lot more than the 700 quid on interest well you've spent 850 quid because there's interest on it as well so interest rates are high you buy stuff which goes down If you're in an awful predicament and you are borrowing money or going into overdraft to buy food, the very definition of it being worthless the second you take it out of the supermarket, right?

6:39Pete:And once you've eaten it, it's crap. Hey! But if you're in, I mean, you know, again, no judgment. Some people have to borrow to buy food. That's a very, that's bad debt. So good debt, low interest, buy stuff that goes up, bad debt, high interest, buy stuff that goes down in value. Cool. is it inevitable is it an inevitable part of life does it have to be oh sorry just whacked the mic stand then does it have to be in my life no I don't think it's inevitable I think a lot of people feel like it is but you can be debt free now are we including good debt here oh yeah look good debt is proper useful I mean most people most people can't buy a house outright well I was going to say that I can't buy a house outright no of course not right and so debt then is a necessity yeah um bad debt is not an inevitable part of life you don't have to take out car finance no you can just keep your older car you can keep your older car for longer you can save and buy with cash you're not going to get such a nice car as you want right but but maybe that's the price of being out of debt right so debt is not inevitable we must not tell ourselves that it is because that's a very sort of passive unintentional way of living yeah so well everybody has a car loan don't they no they don't and you don't have to okay it's not inevitable but most of us will probably have some at some point can you have said debt and save alongside it like save for the future say you can we've talked about good and bad debt right even if you're in bad debt if you are in control of it what you don't want to do is have it get worse and worse then it's out of control my contention is that you should not have bad debt if you can help it and if you have it now we're going to give you some tips on how to get out of it because if you owe other people money you're making them richer, not you far better to use your salary that comes in every month to improve your own financial situation, not the faceless guy who runs the credit card company who's being paid a shit ton of money.

8:55Pete:So you don't want to make him any richer or the shareholders of whatever credit card company any richer. You want to make yourself richer. And you don't do that if you're in debt. So you can save for the future, but it doesn't make any sense to me. I get asked this all the time. It's like, well, I can invest. I can make money on the stock market. I can maybe make 10 % a year. But okay, but that's not guaranteed. Investing and saving, investing particularly is not guaranteed. You don't know what the returns are going to be. Whereas you are definitely going to pay the interest on a credit card. They're going to make you pay it.

9:25Pete:And so it doesn't make any sense. It's like trying to run across a beach with an anchor tied around your waist. You're going to be continually held back. You're not going to improve your financial situation anything like as quick as you would if you didn't have debt. Far better, I think, to go aggressively and pay down the debt. And then you will have more each month to save. That makes sense. And you'll get further ahead more quickly. And I imagine debt especially is so emotional. If you can get rid of, especially bad debt, if you can get rid of the tie. Yeah, it's just good for the soul. Yeah.

9:59All right, we mentioned it then. If you're in a situation where you're listening to this and you're going, I cannot get out of this hole if you've got to borrow to pay back your borrowing or borrow to pay. Or you're borrowing to pay. Yeah. And it's, how do you even begin? Where do you start? Because it happens.

10:19Pete:And it happens a scary amount. It's happening more and more. So if you are in trouble with your debt, if you've got people knocking on your doors for repayments, that's in trouble. If your total amount owing is getting worse every month, that's in trouble. The thing you must do is swallow your pride and get help, right? You don't have to do this alone. It's so important. How do you get help? How do you get help? Yeah, in my head, I'm like, you've got to pay someone? Well, we were chatting about this before we hit record, and you're like, I didn't know that was a thing. So, look, debt is a huge impact on society, and if you are in deep and spiralling debt, this is why people take their own lives.

11:03Pete:Oh, yeah. Trigger warning, I know, but look, it just weighs on your mind. You feel like there's no way out of it. I'd be better off dead. I don't have to think about it, because debt doesn't stop when you die, right? so if you want to get out of it and you I'm sure you do if this is eating you up and you're getting in worse and worse trouble every month you need to get help so where do you do that? so you can talk to citizens advice it can be a real pain to get an appointment they're busy it's like a government sponsored general advice for the citizens of UK cool but if it's three months before you get an appointment then you're even in deeper shit then exactly the two charities that I suggest people talk to if they've got debt issues.

11:45Pete:One is called CAP, C-A-P. It stands for Christians Against Poverty. It's not like an overtly religious. You're not going to get assimilated into a cult or anything like that. It's just it was set up by a bunch of Christians in a church. I think Bradford, actually, my hometown. Oh, really? So the other one is called Step Change. We will put links to these on the show notes, which is bankofdad.show slash episode four. That's the episode that we're doing right now. bankofdad.show slash episode four. We'll put these links on there. So you get in touch with these charities and essentially they represent you to the people you owe money to.

12:20Pete:So if you owe money to sort of three different lenders, then they will negotiate on your behalf an agreement with those lenders. Most people don't know that the lenders have a duty under law to do everything they can to help you. Right. They can't just shaft you. right they now even though you've signed contracts and you've agreed to pay them back if it becomes problematic they have to do everything they can to help you and what the charities know how to do is to press the right buttons and and they will say look my client can't pay you back so we need to come to an agreement as to how much they pay you each week or each month and there are some mechanisms for how to do that it doesn't really matter about the names of those mechanisms or whatever but essentially they will negotiate with your creditors the people you owe money to and uh they will help you manage that they will even help you budget very often okay sometimes they even set up sort of bank accounts so that you know they don't have access to your bank account but you pay it's a step change they will pay the lenders and stuff like that right surely we're not talking much that we're paying in the back you don't pay the charities anything no sorry um when you said negotiating oh you might be talking two quid a week right okay but they will come up with something which is affordable to you okay Right, because otherwise there's no point.

13:35Pete:It's just going to prolong things. Yeah, just continue the cycle, yeah. Crucially, I'm pretty sure I'm right on this, but the lenders don't charge you any interest from the point at which you go into that agreement. Okay. So it's not getting worse. Essentially, you put a cap on the total amount that you owe, and they will then say, okay, it might take you five years to pay them off, but if you stick to that agreement, it won't completely trash your credit score and things like that. Other than that, if you let it go and let it go, eventually you'll be declared bankrupt. The people you owe money to will apply for you to be made bankrupt, which essentially means they might have coal on some assets.

14:09Pete:They may be able to take stuff off you. So if you've got a car, they might take it off you and sell it, get their money back. So we need to avoid that as much. It's better to swallow your pride and say, hang on, I need help. I need help. There's no shame in it. Exactly right. There isn't. It's too easy to get in debt these days. Yeah. Big bugbear of mine. Literally everything you buy online, do you want to pay later? Pay it in three easy installments. I still have to convince myself not to do that because it sounds like it makes sense oh yeah that's actually then I only got 36 quid leaving my account tonight even if it's interest free it's a gateway drug yeah because you've still got to pay it back but now you've got to pay it back down the line it's too easy to forget yeah oh actually I still owe 70 quid on that thing and I haven't got 70 quid so now I'm going to have to go into overdraft and then the cycle begins or pick out another one yeah alright and the cycle begins it's a gateway drug it's too easy and this is why it's so easy to get into this terrible hole because you just end up spiralling so quickly.

15:01Pete:Well, I mean, I remember a time where if you wanted to borrow money, you had to go and see your bank manager, right? You had to go see a very serious man in a very dull suit in an office. And they grilled you and you had to prove that you could pay it. Nowadays, it's two clicks. It's too easy. It is. And it becomes an entryway into it just getting worse and worse and worse and worse. So you've got to be super careful, right? If you're in deep shit, get help. You're not on your own and you can get out of it. cool that's really good to know because I had no idea that existed that is this is so infuriating we're not taught that no so infuriating and it's great that there are charities and places things in place to help you all right now let's take it back a step how can we avoid getting into debt in the first place okay so we talked a little bit about emergency fund yeah obviously we talked a bit in the wanky way of the week earlier on we talked about I've alluded to briefly last week when we're talking about budgeting.

15:54Pete:So emergency fund is like, it's your first line of defense against bad stuff happening and you getting into debt just because the universe threw you a curveball, right? Look, stuff happens. The car is the classic. Cars are expensive to run, right? And obviously your boyfriend had, you know, challenged with his MLT fairly recently. And it's just like, oh my God, right? I wasn't expecting that. I was a taxi driver for a month. You know, I wasn't expecting that. I've now got hundreds of pounds or a thousand pounds bill to pay. I wasn't expecting it. Yes, I wasn't expecting it. It's a shock. If you've got to pay something and you don't have the money to pay it, the only answer is you get into debt.

16:31Yeah. Or you don't pay it. Yeah.

16:34Pete:In which case you don't have a car. Do you know what I mean? Yeah, which causes all sorts of things. An emergency fund is simply this buffer. So we need to get to the point, we do that by using a budget. If we are lucky enough that we don't have any debt, we get ourselves an emergency fund in place. We use our budget to say, I want to build X amount. we'll talk a little bit about how to get out in a minute, but the emergency fund is part of that. But if you're not in debt yet... Build an emergency fund to prevent it. Yeah. You're less likely to go into debt by accident if you've got an emergency fund.

17:07Yeah, because you've got... Or certainly less severely.

17:10Pete:Yeah, exactly. You know, so if you've only just started to build up your emergency fund and you've only got£200 in it and you get a£300 bill... Well, you're only£100 in debt. as opposed to£300 in debt. Exactly. Gotcha. Really important. All right, I'm in debt. I'm not. You're not, but... But this character that I've created, I'm in debt. How do I get out of it? Providing we're not in the snow, like the awful bit where we've said we need help. I'm in debt, but I'd really like to get out of it. Yeah, most people are not in that really dire straits, but they're like, I'm not enjoying this. I'm continually in my overdraft.

17:45Pete:I don't like this anymore. Keep me awake at night. Right? Yeah. So you can get out of it. so tell us pete so you need to get super tight on your spending yeah right that's probably why we're going in this position so the first thing you need to do is to set a budget and you need to stick to it you need to kind of commit to be laser focused everything else doesn't matter right you need to go a little bit monk mode you need not to be uh throwing money away on stuff you don't need it's like if you really want to get out of it this is your number one job yeah literally everything else can wait. Well, maybe not literally, but...

18:20Pete:Pretty much. Obviously, you still have to pay you rent or whatever, your mortgage. Yeah, but it's like, oh, okay, look, I know you really, really, really, really want that game. Yeah. And you're going to get it low to pay from it, but it's not worth it. All debt payments have a minimum payment. All debt. So if it's credit card and overdraft or whatever, you have a minimum payment you have to pay every month. Yeah. Right? So that's like paying yourself first. You've got to pay that no matter what. If you don't want the debt to get any worse, you've got to pay the minimum payment. But what you need to do is screw down your budget so that you can find a little bit more than that every month.

18:53Pete:The first thing you do with that is to build what's called a starter emergency fund. Now, we generally say 500 to 1 ,000 quid. That might seem like a massive amount of money to some people. I get it. But that is there to stop you getting any worse because there's nothing worse than you think, I'm doing really well, I'm paying down debt, and then another surprise happens to you and you're back to square one. So what you want to do is pay minimum payments, on your debts and build up a starter emergency fund, call it 500 quid, that will cover most things. Right? Not the big things, but it'll cover most things.

19:28Pete:Right? Once that 500 quid is in place, that's your starter emergency fund. You will, if you've been screwing down your budget so you can find enough to build that start emergency fund, then that money is still available every month. You're just not putting it in your emergency fund anymore. You're starting to pay down against your debt. We'll do some sort of what have become called power moves, which I know you love, but there's ways that you can accelerate it, right? We'll do that in a little bit, but get that start emergency fund behind you. Now, if you've got more than one debt, let's say you've got three different credit cards and an overdraft, right?

20:01Pete:There's a couple of ways you can think about how to do it. What you need to do is write them down. And the way I tend to do it is called a debt snowball. It's not, I didn't come up with that, right? A gentleman called Dave Ramsey, American finance commentator came up with that, I think. And what you do is you write down your debts in order of size. Forget interest rate. It doesn't matter. Okay. Smallest first. All right. So let's say you've got 200 pound overdraft, but you've got a thousand quid on each of three credit cards. All right. Write down them in, write down your debts in order. Smallest outstanding balance.

20:31So you've got 200, 300, 500.

20:33Pete:Yeah. Yeah. Right. So let's say you've got four outstanding debts written down now in order of size, amount that you owe. What you need to do is you pay minimum payments on debt two, three, and four. And on the smallest one, you find as much as you can in your budget to pay above the minimum payment. So when that one goes, you get a little win. Quick win, right? It's super important. There's so much of money psychology, right? Yeah. A quick win. Oh my gosh, I've cleared one of my credit cards. Yeah. Wow. You get a statement back that says zero. That's good for the soul, right? Yeah. And then the reason why it's called the debt snowball, let's just say you've, the minimum payment on that first debt was, say, 20 quid a month, but you've been paying 50 quid a month off it.

21:12Pete:And now it's gone. You've got 50 quid a month. You were paying minimum payments on the other three. Now on debt number two... You've got the minimum payments plus the extra 50 quid. And the snowball's got a bit bigger. And so you then do that. And by this time, you're saying, right, okay, I can find another 10 or 20 quid in my budget. And you're so excited from the win of the first one. You're like, do you know what? It's not just 50 quid plus the minimum payment anymore. I'm going to make it 75 quid. plus a minimum payment. And you do what you can, and some months you might have to dial it back a bit, but you see it coming down every month.

21:43Pete:Decks three and four are staying largely the same. You pay minimum payments on those, but you start to see debt two coming down. You pay that off, you get a zero on a statement, you feel great. Now, I've got 50 quid a month I was paying off debt one. I've got whatever I was paying off debt two. Now I'm looking at 100 quid a month that I can pay off debt number three. And by the time you get to the last one, you're paying a lot of money off every month. Because you were paying it to four people, now you're paying it to one. and it accelerates the snowball growth. That's a really good analogy. It's amazing.

22:10Pete:And it's super powerful. Yeah. This might take you three years. That's what sucks. You're not going to be able to do it quickly. No. Right? But that's why doing it in reverse, you know, smallest to largest, you're going to get the wins. I think that's the most powerful. Some people get a bit uptight about interest rate and say, well, what you should do is pay off the highest interest rate first. That's called the debt avalanche. It's the same principle, right? Instead, you write them down in order of interest rate. I think that's less powerful than the snowball no you're probably less likely to have the quicker wins yeah because yeah yeah because often you're right the value of having that oh my gosh I've done it yeah I can do it again now so many things in finance maths says one thing emotions and psychology says another you get that all the time on the meaningful money podcast should I overpay my mortgage or should I go on holiday or should I invest which one makes you feel better I'm not sure I get overpay or go on holiday.

23:03Pete:Oh, whatever. Overpay or invest, yeah. Yeah, you get that one. Whichever one makes you feel better. Because lots of people say we've got to lean in to invest, but... Yeah, yeah, no. I think there's a lot to be said. I think paying off a mortgage or paying off a debt is far more powerful than saving interest. Yeah. Right? So screw down your budget, use the debt snowball. Cool. How do you stay focused on that? Well, if it's going to be a two or three-year process, as it might be, it's hard to stay focused, right? distractions come along stuff you want to buy can I ask whilst you're doing the snowball you're still building an emergency fund?

23:41no no

23:41Pete:you've built your that's there you're using the money you were using to build your starter emergency fund right so you've got your 500 to 1000 in that emergency fund and then you just park it park it it's there that will cover most things okay if you get an emergency and your 500 quid starter emergency fund goes down to 200 quid you need to stop and do that again and payments on your payments again and build it back up. Yeah. It's there's nothing more disheartening than working on your debt and then getting a knockback. Yeah. A buffer, an emergency fund kind of stops that. Cool. Yeah, I'm with you.