Debt is a huge part of our financial lives. Whether that's credit cards, mortgages or student loans most of us are trying to manage the proverbial spinning plates of our finances. One of the key goals of many people is reducing your debt or getting out of debt. Using the tools provided by Neon, you can get in the position to manage payments and understand how much capacity you have to spend, save and pay off debt.
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We have a blog article on a similar topic to this that you can see at 4 steps to becoming debt free. We have also got an outline on how we recommend you set up your Neon account and you can find that here).
The most important principles to understanding your debt are:
- How much debt am I in? Both your accruing payments (e.g interest) and your underlying debt
- What is your capacity to pay off debt? When you have made all your payments what do you have left to service this debt
What do I need to do to start?
STEP 1: Get as many accounts connected as you can
You can't understand the big picture if you don't have as many components as possible there.
Before starting the first crucial step is to connect as many of your support bank accounts as possible in order to gain an understanding of your overall finances. Try and connect as many accounts as you can that hold debt (e.g credit cards). Some Credit cards may not be supported under PSD-2 so we won't have connections for them. If so, you can choose to add this as an offline account.
More information about open banking and which connections are supported can be found here.
STEP 2: Understanding your Pay Cycle
Get paid on the last day of the month? Set that up as your pay cycle. Get paid every week? Set that up as your pay cycle. Your pay frequency and value will determine your capacity to service debt. If you don't get this sorted sorting your finances is going to get really challenging. More information about how to set up your pay cycle and what a pay cycle is can be found here.
Note: I am a seasonal worker/have infrequent pay cycles/receive student loans. We will be publishing a separate article on tips on how you can deal with your finances as they pose a unique set of opportunities and challenges.
STEP 3: Setting Scheduled Payments
There are recurring payments you need to make. Whether that's rent, car payments or transport costs there are certain items you pay for every month. Get them set up as scheduled payments. For example:
- Bus pass = £50
- Rent = £400
- Income = £1000
Without scheduled payments you might think you have £1000 to work with this Month. If you spent £1000 before realising you needed to pay bus pass and rent you would accumulate debt/be at risk of having services removed from not paying. In reality you have £550 (Income- Bus pass - Rent) to work with. That is the starting point of your capacity to service debt. It is crucial to understand what you can pay off.
Now we are ready to go
We have now cleaned house. We understand both how much is coming in and when and what must go out and when. Debt usually has 2 parts to it:
- An interest component: Eg the charge you pay for being in overdraft
- A principal component: Eg the value of how much you are in overdraft
This style of debt essentially says, the more debt you are in the higher interest charge you will pay per month to have it. This is debt we can use tools at Money Dashboard to sort out.
Understand how much you have to pay
Use budgets. Get your credit card interest payments and get them categorised. Whether that's a custom category or a pre-set one it doesn't matter. We need to understand how much you pay every month to service your debt. At the end of your pay cycle take note of how much you owe as principal for each of your accounts.
E.g You have £600 on your credit card that you have previously rolled (This is the principal) and have to make a payment of £35/month interest (That is your servicing cost).
Some people are happy to have rolled credit card debt. Others are not. We are going to focus on removing the principal debt. This way we also remove the interest payments.
Understand how you spend?
You already know the areas you may overspend in. Get your budgets set up. It can be painful at the start to see how much you spend and where but it is a necessity. More information about how to set up a budget and what it is can be found here.
What do I know now?
You now know the 3 critical components to getting out of debt:
- How much debt do you have?
- How much money do you have coming in after you make all your necessary payments?
- Where do you spend your money (And by consequence, where do you potentially overspend)
The next steps
I would love to tell you what credit card to pay off first. But we can't. HOWEVER:
You now understand whether you have more coming in every month than going out. Although its a painful process you understand how much you pay to be in debt. You understand where you spend your money. You understand your pay cycle and what payments you deem mandatory. You now have the information to make the decisions to pay off debt.