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From mortgages and budgeting to pensions and lending, there are plenty of branches to the financial affairs tree. Meg Winton quizzed Adam Dawson, chief executive of Reto Finance, on the common questions surrounding managing your finances
GOOD money management is a fundamental part of setting yourself up for the future.
But for some, knowing how to look after your financial affairs effectively might not come easy.
Although “reto” means “challenge” in Spanish, this is not what Adam Dawson, chief executive of Reto Finance, wants people to feel their personal finances are.
As a financial services professional, he can shed some light on the most common questions, queries and points of confusion when it comes to personal finance.
Adam described Reto Finance as a non-bank lender that provides funding to local residents and businesses. Customers come to his team for a loan to support anything from mortgages and home improvements to purchasing a vehicle and wedding expenses. Each of these financial commitments requires some level of budgeting or saving, whether you are seeking a loan or not.
“Budgeting is important because we have a responsibility to not spend more than we have,” Adam explained.
“Approaching your own personal balance sheet, so what you earn versus what you spend, in a sensible and grown-up way is pretty important.”
For some people, something as simple as an Excel spreadsheet is enough to keep track of their personal finances.
But Adam said it was important that a budget was “factual”, not “aspirational”.
“What do you have coming in every month? What savings do you have, depending upon what stage of life you are in?”
Having an understanding of what’s to come was also key to effective budgeting, he added.
“If you’re young and perhaps living at home, you might not have any rent to pay. That’s likely to change, so what are you doing to prepare for that?”
Adam highlighted that there were tools and approaches to help with budgeting, such as the 50-30-20 rule.
This involves taking 100% of your income, inclusive of what you earn from savings and investments, allocating 50% to necessities, 30% to “wants” and 20% to savings.
“You need to pay your rent or mortgage, food bill, utilities, light and heat, so 50% of what you earn should be focused on that,” explained Adam.
The 30% “wants” allocation could account for what you spend on going out for meals, holidays, or treating yourself to a new pair of shoes.
He added that dedicating 20% to savings was a “good rule of thumb”.
“That possibly sounds like quite a lot, and it will vary at different stages of life, but you put yourself in a relatively strong position,” he said.
Another approach was the “six-month rule”, where you saved six months’ worth of your income.
“You never know what’s around the corner,” said Adam. “Whether you lose your job, or you’re ill and can’t work, or you’re self-employed and injure yourself so you can’t earn, things can start to derail quite quickly.”
Having six months of income saved up, he added, provided a “buffer”.
“You’ve got six months to stop the wheels coming off. Thinking about putting something away to build up that six-month buffer is a really good idea.”
A house was what Adam described as “the most expensive purchase” most people will make in their lifetime, which was why many chose to support it with a mortgage.
“You’re borrowing money to buy your house, and what you’re providing in return to the lender is security,” Adam said. “And the security is your house.”
This means that if you don’t keep up with your mortgage payments, the lender could take possession of your house to settle their debt.
Adam said this arrangement was called “secured debt”, and it was considered low risk to the lender because property as an asset would probably “appreciate over time”.
“Rate for risk”, “rate of interest” and “loan to value” are three more terms you may come across when trying to secure a mortgage, and they are all linked.
Rate for risk is dependent on what lenders, such as Reto Finance, perceive the risk of the borrower to be, so money is lent at different rates of interest.
“Your risk is reduced if you’ve got some security, and therefore interest rates are typically lower,” said Adam.
That rate of interest varies depending on how much you want to borrow and the value of the property you’re buying.
“If a house is worth £100,000, and you need to borrow £90,000 to buy it because you’ve got a £10,000 deposit, your loan to value is 90%,” Adam explained.
This is why he emphasised that saving up and budgeting in the lead up to securing a mortgage was key.
“The more you can save and the bigger the deposit, the lower the loan to value is, and the lower the interest rate is,” said Adam. “By being a bit sensible and lowering your loan to value, you typically can borrow money cheaper.”
Credit cards are a type of borrowing many of us will be familiar with. You’re allocated a certain amount of credit per month which you are expected to pay off.
“If you’re really good, at the end of the month you pay your bill off in full, so you don’t pay any interest,” said Adam.
Credit cards could be an efficient way of borrowing, he added, especially if you have saved up for a large purchase. But Adam explained that the flexibility and ease of credit cards was also their downfall.
“It’s very easy to run up large bills that you haven’t got enough money to pay off, so you pay a bit of it off.
“You then start getting charged interest on the balance that’s left, and typically those interest rates are quite high, north of 20%, 30%, 40% and even 50%”, he said.
This could result in spending much of your income each month trying to “service that debt”, which doesn’t reduce the capital, but rather “treads water”.
It was a problem that could quickly get worse, Adam noted, if people funded further purchases through new credit cards.
“Those interest bills start to rack up,” he added.
If you do find yourself in a spot of bother with debt, lenders can offer a solution called a consolidation loan, which aims to improve your debt position.
If you have a few sources of debt with high interest rates, like credit cards or an overdraft, a consolidation loan provides you with the funds to pay them off.
“You come to somebody like us, and we pay the credit cards off for you,” Adam explained. “And you make one payment to us every month for a fixed period of time, typically at a much lower rate of interest.”
He joked that consolidation loan agreements needed to come with a “pinky promise” that the customer would “cut the credit card up” and not use it again.
“It’s a way of getting yourself out of that debt situation,” he added. “You might take the loan out over two, three, four or five years, but at least you know that if you make that payment every month, you clear the debt.
“You are paying down the capital over time,” he added.
Are you going to rent? Are you going to buy? What are the costs associated with that? Most people can’t suddenly decide to buy a house. They need to save for a deposit, stamp duty and legal fees
Adam Dawson
Long term, there will always be reasons to save and budget, whether that be for your retirement or for unexpected or major life events.
Those moments are what Adam said were the points at which your personal financial situation came under the most scrutiny or pressure.
Being prepared and mindful of that should start at a young age, he added, when you begin paying for things yourself.
“You might have a car. It needs to be insured and maintained, so figure out how much that would cost a month, and then put that into your budget,” said Adam.
The same approach goes for larger purchases, like a house.
“Are you going to rent? Are you going to buy? What are the costs associated with that? Most people can’t suddenly decide to buy a house,” he added. “They need to save for a deposit, stamp duty and legal fees.”
The costs associated with having a family, putting children through education, moving house and everything in between should be factored into budgeting as you went through life, Adam explained.
And your retirement should be something you plan for from as early as possible.
“You’ve got to plan for when you’re not working,” he said. “What do you want to be doing in retirement, and what is that going to cost?”
“It sounds a bit boring and grown up, but planning for these things is way more sensible than them creeping up on you without you realising.”
Listen to the full podcast with Adam by scanning the QR code.
