Silly Credit Card and Financial Decisions
When interest rates started rising, Gary and Sue took it in their stride. They didn't feel they needed to cut back at all even though the mortgage interest payments went up to £791 per month in February 2004. They let their credit cards take the strain. They were a bit surprised at the £10,000 credit limit they were each allowed on their separate credit cards, but if the banks were happy, who were they to quibble? They paid the minimum payment each month.
Their house didn't need a new kitchen, but they decided to have a new bathroom and the company that provided and fitted it for £6,000 were happy to be paid on Sue's credit card.
Gary and Sue were lucky that their house, unlike Janet and John's, wasn't damaged in the April 2004 storm. However, when Sue became pregnant in November, they weren't as delighted as Janet and John as they had not been planning to have a baby for another two or three years, when they were confident Gary would have a promotion and a much bigger salary.
The prospect of the baby made them look at their finances. They realised that their credit card bills were fairly daunting. Between them they had £15,000 outstanding and were paying £150 per month in interest charges alone. They decided that what they needed to do was to increase their mortgage to take advantage of the fact that the house had increased in value to £260,000 by January 2005. even though the big increases in house prices in 2003 and 2004 had begun to slow.Gary felt his car needed replacing - it was, after all, four years old. If they raised another £25,000 on the mortgage. the repayments would only go up to £ 1,030 per month and they could use the money to pay off the credit card debt and buy a new car. That seemed to them a pretty shrewd financial deal: the mortgage was still only £215,000 on a house valued at £260,000.
When interest rates went up again in July 2005 they had risen 1.5% since they first took out their mortgage. The minimum lending rate had gone from 3.5% in the summer of 2003 to 5% two years later. Mortgage rates had gone from 4.5% to 6.0%. 1.5% didn't sound a lot to Gary and Sue, but to their surprise, they found their monthly mortgage interest payments had risen from £712 per month when they took on the mortgage to £1.075 per month now (including the additional loan of £25,000). £363 per month was a big increase, even for middle class professionals like Gary and Sue in reasonably well paid jobs.
Of course, they were an intelligent couple and realised they would have to cut back now that Sue was going to be on maternity leave. She wouldn't be able to go back to work very quickly as they had no relatives living close by to help with childcare. In any case, when Robert arrived. Sue was so enchanted with him that she knew she couldn't leave him with a babyminder or in a creche all day - even if she could find one at a reasonable cost. They would have to learn to live on Gary's income.
Unfortunately, a significant proportion of Gary's income had been in the form of performance bonuses. As the economy slackened off towards the end of 2005, the amount of work available reduced and so did his bonuses. His salary fell back towards his basic of £23.000.
They now had mortgage interest payments of £1,075 to meet out of a net monthly salary of £1,400. With their other living costs of at least £1,000 per month and the expenses of a new baby this was clearly going to be impossible. And so it proved.
At first they coped by buying essentials on their credit cards. This helped their cash How, but they soon realised that the total credit outstanding was going up fast, along with the interest payment and the minimum payment due. Sue found a child minder and returned to work part time. Unfortunately, the child minder was on the other side of the city from where she worked. She hated leaving the baby with someone else, but she had little choice.
Even so the time and cost of getting to the babyminder in the morning and collecting him in the evening on the two days a week she worked made the working days totally exhausting. And after she had paid the taxi fares to do it (she had sold her car when she stopped working) plus the cost of the child minding, there didn't seem much money left from all that effort - certainly not enough to solve their financial problems.
The credit card bills got bigger. Then their bank wrote to them to say they had gone above their authorised overdraft. That one month's unauthorised overdraft of
£30 cost them £50 in charges and interest. The same thing happened the following month and the hank, after making the same charge again, agreed to give them an increased authorised overdraft facility of £250 at 16% p.a. interest. They started getting final demands for electricity, gas and telephone bills. The bank agreed to increase the overdraft to £1,000, but soon they were running up to that limit too. The bank said it could not increase the limit further.
In January 2007 the bank refused to accept the direct debit on council tax. The following month the bank did the same for the mortgage interest. Gary and Sue did not know which way to turn.
They had to eat and heat the house and Gary had to have the car to get to work. January and February of 2007 were exceptionally cold months and the gas bill was enormous when it arrived in March. They put it on the mantlepiece and tried to forget about it. The same with the electricity bill.
Gary and Sue's action plan
The rest of the story is sadly inevitable. The arrears on the mortgage built up. The utility companies threatened to cut off services and the credit card company refused to accept further charges to the card until the backlog of minimum payments had been made.
They had to have gas and electricity in a house with a young child so they agreed to prepaid meters charged at a higher rate per unit until the arrears were paid off. The bank saw that they were in trouble and ended the overdraft facility. It also immediately deducted the full amount of the overdraft, plus outstanding interest, from Gary's April salary cheque. This left precisely nothing in the account for the rest of the month. The building society warned them that unless they got their interest payments up to date they would start repossession proceedings.
Gary and Sue went to see the building society, which told them they would not press for arrears for six months, provided the current payments were kept up to date. The building society thought this was a reasonable offer, but with no money to pay the April interest payment. Gary and Sue almost immediately defaulted on the agreement. Repossession proceedings started.
Sue had got into arrears with payments to the child-minder too. The lady was sympathetic for a month or so. but when she saw things were going from bad to worse, she told Sue she couldn't take the baby any longer. Sue had to give up her part-time work.
We don't need to go into the gruesome details of the final months of 2007. They tried putting the house on the market to downsize to a smaller and cheaper house. But the housing market was now very different from 2003. Prices had started to fall and there were no buyers. The estate agent estimated that to be certain of a sale they would have to drop the price to £210.000: £10,000 more than they paid for it, but a lot less than they owed the building society. When the interest arrears were added to the £215.000 borrowed, they were trapped in negative equity.
By mid 2008 Gary and Sue's house had been repossessed and they were living in a small, rented flat in a far from salubrious area. They had trouble getting credit for anything. They wondered where they had gone wrong.
Where Gary and Sue went wrong.
Of course, with the benefit of hindsight, we can see clearly where they went wrong.
- They went for the biggest mortgage they could afford
on an interest only basis when interest rates were at a
historically low basis. They did not take account of the
fact that a significant amount of Gary's salary was
bonus which could be cut without notice. When
interest rates went up their payments went up by a
far greater percentage than would have been the case if
they had had a repayment mortgage.
- They did not consider whether they could pay their mortgage and credit card bills if their circumstances changed - e.g. Sue becoming pregnant.
- They allowed a large amount of long-term debt to
build up on their credit cards at a high rate of interest.
Despite rising interest rates, they increased their
already high mortgage to pay for something that was going to fall in value - a new car.
- They did not have an emergency savings fund to cope with emergencies.