These days, a little debt is part of day-to-day life.
Most people have mortgages and credit cards, and many have car loans, personal loans and student loans that they are making regular repayments on as well.
Credit is an important aspect to the economy, and this is no bad thing. However, it does add a complexity to managing your finances that was less prevalent in days gone by. Here is a look at how debt works, the mechanics behind your credit score and what you can do to improve your finances if you are struggling.
Some statistics
First, it is worth taking a look at some stats to get a feel for how large a part that credit plays in modern-day British life. The average household owes more than £56,000, including mortgages. That equates to £29,700 per UK adult. When you take into consideration the fact that the average annual salary is £27,600, it gives you an idea of just how reliant people are on credit.
Of course, you might say that this is mostly down to mortgages. Not entirely – credit card debt stands at more than £2,500 per household. At the average rate of interest, this would take more than 25 years to repay if you just made the minimum monthly repayments.
Credit scores
The above suggests that credit is available to all, but it depends on that mysterious thing that everyone has heard of but few understand: the credit rating or credit score. This hinges on a number of factors, and not all relate to your borrowing history.
If you are a homeowner with a steady income, then this will improve your score, and those who have used credit sensibly also score well. This means that you get a better rating if you have plenty of debt but always make at least the minimum payments than if you have no debt at all.
If you have missed a payment or regularly exceed your overdraft limit, then these are all factors that count against you. A poor credit score does not necessarily mean that you will be denied credit (although it might), but it will almost certainly lead to you being charged higher rates of interest, as you will be seen as a greater risk.
Got PPI?
The huge amount of credit being offered to consumers led to one of the biggest financial scandals ever seen a few years back, when customers were improperly sold payment protection insurance. You are almost certain to have heard something about it and have probably received some of those annoying phone calls, but you might not know the full story.
In short, more than 50 million payment protection policies were sold to consumers. The policies were designed to cover repayments in the event that the consumer was unable to do so, and thereby protect against default. The problem was that a huge proportion were sold by making misrepresentations to the clients, for example, that the cover was mandatory.
The fallout was that 12 million consumers were able to claim compensation. All the high street banks were involved to a greater or lesser extent, but the one with the famous black horse sold more than all the rest, and so many customers have submitted a Lloyds PPI compensation claim, of which the total pay-out currently stands at £17.4 billion.
Improving your credit score
Claiming PPI compensation is certainly a no-brainer and will be likely to create a nice cash windfall, but if you are struggling with a poor credit rating, then it will not help you there.
Credit scores are built up over time, so there is no silver bullet to repairing yours. There are, however, some simple things that you can do to start the process of recovery and get off on the right foot:
1) Get on the electoral roll
This makes you look more solid and settled. If you are not on the electoral roll, then you are unlikely to get credit.
2) Get a credit card
As we said earlier, you need to show that you can handle credit. Get a card, use it for a few transactions per month and always pay the bill.
3) Pay your bills
You probably have regular payments going out for electricity, phone, Internet and so on. Make sure that these get paid on time, and your credit rating will start to climb. Conversely, if a direct debit bounces due to lack of available funds, then your rating will drop.
Building up a solid credit rating is not easy, but these steps will get you on your way. Good luck!