Taking out credit has become an everyday part of life – whether that’s using a credit card when savings run low, using car finance agreements, or applying for a loan to pay for a big expense.
Financial literacy is hugely important to ensuring every borrower understands the terms they agree to, with the skills to compare interest rates and early repayment penalties.
In this guide, we’ll go back to basics and run through the four essentials you need to nail down before you can make sound borrowing decisions, as explained by the credit experts at Wonga who liken these four essentials to the ‘pillars of financial literacy’.
Taking on Debts
Consumer debt is readily available, but the difference between affordable, responsible finance and credit with cripplingly high-interest charges is a deep, dark chasm.
Debt in itself isn’t always a bad thing. It can be a necessary part of managing household finances, helping to build a healthy credit score with a history of timely payments and good credit management.
Just about everybody will have some element of debt at some stage, which could be:
- A credit card, as a backup in an emergency.
- Student loans to cover living costs at college.
- Mortgage products to purchase a home.
- PCP or HP on a car finance agreement.
The crucial thing about debt is that it should be firmly controlled, with an awareness of how much you owe, how much you need to pay back per week or month, how much it’s costing you in interest, and how long it’ll be before you’re debt-free.
A debt repayment that consumes more than 30% of your take-home pay may require some attention. Perhaps you can consolidate through lower-cost borrowing products, refinance through the Citizens Bank program, or restructure over time.
Building Up Savings
We all recognise that savings offer valuable protection against unforeseen financial disasters – thinking about car repairs, sudden job loss, or another unexpected cost.
The best way to start is just to start, regardless of whether you have a small amount you can deposit in savings each month.
Many people don’t consider it worth opening a savings account if they don’t have a substantial amount of expendable income. Still, the reality is that even a £10 monthly deposit adds up to £120 a year, or £600 over five years, which could come in very handy if you find yourself in a tight spot.
Interest earnings also mean that if you earn a little more than you need for essential items, you can slowly start to accumulate a larger savings pot. However we must point out that interest earnings are at an extremely modest 0.25% currently. This is in fact one of the very lowest levels to occur in 328 years since the Bank of England formed the base rate in 1694.
Automated transfers can work well each time you get paid, and you’ll often not notice a small amount going into your savings.
One piece of advice is that, ideally, you should focus on paying off short-term debt, particularly high-interest accounts such as unsecured loans or credit cards, before opening your savings account.
That’s because the interest payable on debt is inevitably higher than the interest you’ll earn on savings, so it makes sense to use any extra earnings to pay back debts as quickly as you can.
Creating a Household Budget
Budgeting isn’t ever the most exciting aspect of adult life, but it can make a profound difference to your spending habits!
Here’s a quick guide:
- First, work out how much you earn per month between all income earners in your family. You can include salaries, regular bonuses, anticipated overtime, tax rebates, income from second jobs or rental properties, benefit income and everything else.
- Next, go through your bank statements or direct debits, and list all the essential outgoings. That’s things like rent or mortgage payments, debt repayments, utilities, grocery shopping, education fees, fuel or travel costs.
- Once you’ve been through these steps, you will know how much of your regular income you need to spend on necessary items and what you have left to play with.
- You can also use this exercise to rationalise your costs. Can you get your insurance cheaper through another provider? Would remortgaging cut down your monthly payments? Do you overspend on groceries and have the opportunity to bring that cost down by following a specific list of only what you need?
- Each time your income or bills change, you can amend the total on your spreadsheet or download one of the many budgeting apps available to keep an eye on your finances.
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The process is ideal if you don’t seem to know how much you’re spending, end up overdrawn every month, or want a sure-fire way to make decisions about paying back debts or opening a savings account.
It’s often very surprising what we spend on things we don’t need (think takeaways, treats at the supermarket or coffees) so getting to grips with your spending habits makes it obvious where you’re eating up your surplus income.
Finally, let’s talk about investment – which can be as simple and low-risk or complex as you like. Most people new to investment perceive that they need to have huge capital to buy stocks and stand to lose everything if things don’t work out, but that’s an incorrect assumption.
There are multiple ways to make your money work harder, even if you have a minimal amount to invest:
- Online investment brokerage platforms have varying minimums, but you can create an account with a deposit of as little as £10 on some sites.
- ISAs and high-yield savings accounts are great products if you don’t feel confident picking shares or other investment structures. You need to give notice to make withdrawals but can earn significantly more interest than through a standard savings account.
- Crowdfunding is increasingly popular, and you can buy equity shares in brands you love or invest in start-ups with a concept or idea you feel passionate about. It’s usually a long-term game, and you won’t get immediate returns, but it can be a way to experience investment with contributions starting from about £5.
Of course, if you’re investing anything more, you should speak to a financial advisor. They will analyse the risk exposure and pick diversified investments so you don’t run the potential hazard of losing all of your assets if a particular market stalls. We would also recommend checking out the free investing guide from Money Helper as a base point.
All four of these concepts – debt, savings, budgeting and investment are accessible to households with any income level, so understanding what it all means and making informed decisions is the best way to provide for a comfortable financial future.