When credit is a dirty word, the debt must go

The Patient

Since moving to London from Finland eight years ago, Nora Maki has been focusing on settling into her new life. Now the 30-year-old is keen to ensure her finances are well placed to cope with the turmoil in the credit markets and to secure her future.

"First off, I want to repay debts," says Nora, who currently rents a home in Balham, south London. "With banks imposing strict lending conditions, I am particularly keen to wipe these out and build savings."

She has a variety of debts, paying £247 a month for a £10,000 personal loan at 8.9 per cent with HSBC over four years, taken out to help meet rental payments and living costs. She also has £1,300 on an MBNA MasterCard on an interest-free balance-transfer deal until March next year.

In addition, in the wake of a degree course in Finland, she pays €€550 (around £425) twice a year towards a €€10,000 student loan.

"The system is different to student loans in the UK," she explains. "You start paying off any loans two years after graduation, whether you are working or not, and I choose to make payments twice a year to cut money-transfer fees."

Nora manages to service these debts on a salary of £22,000 as a public relations account executive.

To safeguard her income and debt repayments, she pays £45 a month for accident, sickness and unemployment cover with HSBC, as well as £52 a month for critical illness and life cover at the same bank. "I blindly bought these policies and am unsure if they are the most suitable, and even how much cover they provide," she admits.

For short-term savings, she has £500 in an HSBC account paying 3.2 per cent, to which she contributes £50 a month. She also has £1,500 in a cash individual savings account (ISA), also with HSBC, paying 4.7 per cent.

These sums will eventually be put towards a deposit to buy her first property. However, with the current sharp decline in UK house prices showing no signs of abating, she is in no hurry to clamber on to the ladder. At present, she pays £395 a month for a room in a two-bed flat.

Nora also hopes to build an investment portfolio, although she is unsure which assets to choose. "I might invest in alternative classes such as art and jewellery, along with cash and equities to provide more stability."

Looking towards retirement, Nora has been paying 2 per cent of her salary into the company's money purchase pension scheme for the past year and a half. This, she realises, is well below the amount required to provide anything like the sort of income on which she can retire comfortably.

The Cure

Wiping out debt is a wise first step for Nora in sorting out her finances, agree our panel of independent financial advisers (IFAs). However, she must also revise her protection policies to ensure she would be able to continue towards this goal were she to lose her job or fall ill.

"She is paying over the odds for these policies and they are most probably not even suitable for her," stresses Alex Pegley from IFA Calculis.

Debt

Nora should consider how to deal with her credit card debt when the interest-free deal comes to an end. "Along with the impact that recession may have on her finances, the credit crunch is likely to be ongoing and she will really feel the pinch if she is unable to find another similar [interest-free] deal," warns Mr Pegley.

Using some of the cash in her HSBC savings account to reduce this debt would be sensible, adds Chris Wicks from IFA N-Trust Group. "She should divert contributions from her savings account towards repaying her credit card and overpaying on her personal loan, if possible, to avoid paying far more in interest than she earns on her savings."

However, Nora should not redirect all her savings towards debt repayment as she needs a cushion in case she loses her job because of the impending UK recession.

Protection

Paying around £100 a month for the different types of cover held by Nora is "excessive" for somebody in her position, says Danny Cox from IFA Hargreaves Lansdown.

With no dependents, life cover is not an important requirement. Her accident, sickness and unemployment insurance will cover repayments on her most important bills should she be forced out of work by an accident or illness or made redundant.

However, these policies tend to be far more expensive than other types of cover bought through a broker. Typically, most only pay out for around six months, making them costly considering the monthly premiums.

Income protection insurance would be a more suitable solution, our advisers say. For example, as a 30-year- old office worker in good health, Nora could get a full income protection policy with benefits of £1,000 a month for a cost of £26. And she could add unemployment cover for a further £19.20 a month.

This would more than halve her current payments towards protection. She could then split the money she saved, directing some to debt repayment and the rest towards a contingency fund for a rainy day.

Savings/Investments

Nora's intention to invest long-term in a range of diversified and wide-ranging assets is admirable. "But in the immediate future her focus should be on cash," says Mr Pegley.

Saving into a cash ISA, where Nora will benefit from tax-free interest payments, is the wisest choice, rather than her HSBC savings account which pays a paltry rate. With banks currently keen to attract deposits, she should search for an ISA offering a hefty return, such as the Post Office deal paying 6.25 per cent.

Ideally, she should save three months' salary as an "emergency fund" as well as building up a deposit for a property purchase, although the advisers recognise this will be an uphill struggle.

Retirement

As a rule for someone of her age, Nora should be setting aside 10 to 15 per cent of her salary for a retirement fund.

"So the 2 per cent she is putting towards her pension is far from sufficient," says Mr Cox. "It is a good start that she can build upon, but she needs to think about drastically upping her contribution."

The key point with pension saving is that an early start on substantial payments can make a big difference to your retirement income.