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Case Study: Route to clearing debts By Hannah Ricci
The profile Newlyweds Claire and Jake Wright* live in Hamble in Hampshire. Claire, 33, has been training to be a vet for the past five years, and started work in September earning around £1,560 a month. Jake, 35, The Wrights jointly own a £230,000 buy-to-let property near the Bristol Veterinary School. They have a mortgage of £175,000 that they are repaying at £780 a month, and this is more than covered by their five student tenants who pay £1,300 in rent. This is where their joint financial commitments end. Claire and Jake's home is worth approximately £500,000 and the mortgage is held in Jake's name. He repays £1,600 a month with help from a lodger who pays £350 a month. Jake owns a further six buy-to-let flats in Cardiff, worth £495,000, with a mortgage of just £50,000 on one of them. He also has £15,000 in three savings accounts. Claire on the other hand has accumulated a whopping £65,300 debt over the past five years. She has five credit cards totalling £13,800, in addition to a £6,000 student loan, two student overdrafts totalling £3,500 and a £12,000 career development loan. Claire also has two graduate loans totalling £28,000 and borrowed £30,000 from her parents to pay the deposit on the Bristol property. Repaying her debts costs Claire nearly £1,200 every month. "We feel we could do better in terms of managing my debt and securing our future," says Claire. "I would like to be debt-free in 10 years and we would like to have children fairly soon." Expert's advice Philip Pearson, from P&P Invest in Southampton, says now that Claire and Jake are married they need to consider working as a team financially. "The imbalance between Jake's assets and Claire's liabilities will work against Claire's aim to move forward financially," explains Pearson. "I strongly advise that they consider redistributing income and assets from Jake in favour of Claire to repay her debts and start regular saving. Without this approach, hard-earned income will be spent each month on debt interest payments that only benefit the bank." Pearson recommends Jake consider selling one of his properties and using the equity to repay Claire's debts. "This will be the most cost-efficient means of maximising their assets together, otherwise the cost of Claire's debts will overwhelm her future income and provide little scope for saving," adds Pearson. Large debts Despite Pearson's advice, Claire and Jake are keen to keep their finances separate until they have settled into married life, which means Claire is faced with the difficult task of clearing her massive debts alone. The first step for Claire - now she has a regular monthly wage after a number of years in education - is to work out a budget to ensure she manages her money without increasing her spending. Claire wants to start contributing to the mortgage on their Hampshire home, but this will have to be put on hold because after repaying her debts each month she is left with only £360 to live on. "Claire needs to draw up a budget because without it there is a high risk she will increase her debt even further," says Pearson. "I advise Claire to keep a diary for the next 30 days, where she records every penny she spends. At the end of the month, she will be able to identify exactly where her cash is going, highlight where savings can be made and impose a limit on non-essential expenditure." Repayment plans Meanwhile, Claire needs to work out a repayment plan for her debts, which are growing day-by-day. "Claire should create a spreadsheet to help her understand and manage her loans," explains Pearson. "She should note the lender, the amount borrowed, the interest rate and term of the loan. This will help identify the total amount Claire has borrowed and enable her to prioritise repayment of the most expensive debt first." Credit cards are normally the most expensive, but Claire has so far benefited from low introductory rates. "However, these rates finish shortly, so Claire needs to find out how much she will be charged at the end of the introductory period," says Pearson. "Then the cards charging the highest rate should be repaid first." Claire also needs to review her loans. "Her career development loan from Barclays is expensive at 13% AER. If the terms of the loan allow it, she should refinance the debt on a lower interest rate with an alternative lender," explains Pearson. Claire needs to put some protection in place to ensure Jake would not be lumbered with her debts should the worst happen. Jake has life insurance in place to the value of £250,000 - which is written in trust to his two children from a previous relationship. Claire has life insurance of just £20,000, which is insufficient considering Pearson has calculated that she has debts of almost £300,000 across her credit cards, loans and mortgage. "Given Claire's age - however - life cover is very cheap," says Pearson. "For example, £300,000 of life assurance can be obtained from Norwich Union for only £11.72 each month over a five-year term." Savings plan Jake has accumulated around £15,000 in savings, but Claire has none. While repaying debts is Claire's priority, she can earn up to £150 extra for working night shifts, so Pearson advises her to save this income to build an emergency fund. This is important to ensure Claire can cover any unexpected costs that may crop up in the future, without borrowing more. Pearson advises Claire to open a cash ISA (individual savings account), where she can save up to £3,000 a year tax-free. "National Counties Building Society's Guaranteed ISA is providing a competitive 6.26% interest from a minimum £1 deposit," he explains. In terms of provisions for retirement, Jake has a private pension with Standard Life and his portfolio of rental properties, while Claire has two small occupational pensions from previous jobs. "Claire's new employer offers a pension, which is definitely worth taking up because they will contribute to the scheme as well," explains Pearson. "However, given Claire's limited resources at the moment, I do not advise her to contribute yet." Worst case scenario Finally, the Wrights need to look at arranging wills and should seek legal advice from a solicitor. "Any arrangement they had in place before they married is now null and void," says Pearson. "Claire could be faced with a significant inheritance tax (IHT) liability in the event of Jake's death, due to the potential value of Jake's assets and they need to undertake some estate planning to ensure that this liability is minimised." Transfers of assets between spouses are free of IHT upon death, but the amount that can be passed onto the next generation is capped at £300,000 and anything in excess of this is taxed at 40%. "To reduce the impact of this tax, I advise a redistribution of assets between Claire and Jake, so that each is able where possible to minimise their liability," says Pearson. "By doing this, they could save more than £120,000 of unnecessary IHT and this planning can be incorporated into their wills." * Names have been changed.
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