Avoiding over-indebtedness

Is Luxembourg really a utopia where nothing goes wrong? It’s not quite as simple as that in reality. In the face of social pressure, it can be tempting to live beyond your means, taking out a loan to finance a new car, your next skiing holiday, or even to pay off existing debts. But a loan is a binding contract, and without a clear overview of your budget and recurring expenses, you risk becoming over-indebted. myLIFE is on hand to offer advice and help you navigate this tricky subject.

The meaning of the word

Luxembourg law defines over-indebtedness as “the manifest inability of a debtor to repay all of their non-professional debts due or falling due.” But what do we really mean when we say “debt”?

• There are debts that we qualify as ongoing, such as rent, electricity and internet bills, and any home renovation costs.
• Then there are debts in the form of a mortgage, consumer loan or car loan. These involve borrowing money that you have to pay back with interest, generally on a monthly basis.

Simply having to make loan repayments or experiencing temporary financial difficulties does not mean you are over-indebted. This happens to a lot of people, especially young people looking to become homeowners. So don’t panic! Loans aren’t the enemy, although it is important to acknowledge that more often than not, over-indebtedness is caused by abusing them. Before you take out a loan, ask yourself one simple question: “is my income enough to cover both my recurring expenses and my loan repayments?” If the answer is no, you risk becoming over-indebted and should certainly think twice before you sign.

Over-indebtedness is an adverse, persistent financial situation that could result in prosecution in a court of law. The SICS (over-indebtedness information and advisory service) defines over-indebtedness as when “a household’s net income is insufficient to cover its recurring expenses over a period of six consecutive months.”

Most people applying for financial aid are single, rent their home, are between 30 and 50 years of age and are regularly employed.

The situation in Luxembourg

According to the available data, more than 60% of households are in debt (i.e. have taken out a loan). In addition, 543 applications related to over-indebtedness were filed in Luxembourg in 2017.

Most people applying for financial aid are single, widowed or divorced (71%), rent their home (67%), are between 30 and 50 years of age (66%) and are regularly employed (58%). More than half have also taken out a foreign loan (53%).

The causes of over-indebtedness may be personal (inability to manage money, chasing a higher social status, accident or injury, addiction, etc.), social (lack of financial education, the role of loans in our society, aggressive advertising, etc.) or financial (inflation, unemployment, lower wages, missed payments, etc.).

This can have devastating consequences for your wellbeing (loss of self-confidence, depression, suicidal tendencies, etc.), social aspects of your life (isolation, dependence on benefits, family conflict, divorce, etc.) or your finances (loss of employment or residence, long-term reduction in the household budget, etc.).

Generally, a debt ratio above 50% of your available income carries a risk of over-indebtedness.

How to determine your debt burden

To find out whether you’re at risk for over-indebtedness, you first need to know your debt ratio, which is your monthly income versus your total monthly expenses. You calculate this ratio by adding up your debts for a given month (rents, bills and loans) and comparing them to your net monthly income. Generally, a debt ratio above 50% of your available income carries a risk of over-indebtedness. Even a debt ratio above 30% is a cause for concern and means you should be careful!

Recommendations

Before taking out a loan for whatever reason, make sure you have a clear idea of what your available budget will look like in the future. Are you sure you’ll be able to pay it back? Will you have enough money left once you account for any necessary expenses like rent, food shopping and household bills?

The best way to do this is to draw up a monthly budget with a precise and objective list of all your expenses. Don’t forget to include what goes into your savings account! Savings are essential if you intend to take out a new loan. They’ll help you avoid any nasty surprises and keep you from ending up in debt. Without savings, you’ll have nothing in your budget to get you past any hiccups.

Remember that loans are paid back over time and you never know what the future will bring. Try to give yourself a little leeway in your calculations, and consider taking out insurance alongside a consumer loan to protect you against unforeseen events such as losing your job, divorce, or costly medical bills.

And if things do go wrong, don’t shut yourself away! Contact your banker or your creditors to go through your situation carefully and see if you can’t renegotiate your payment dates. Though it may seem difficult at first, try to speak to your friends and family too. They might be able to lend a helping hand, even just temporarily.

You should also pay attention to the type of loan you’re taking out – especially the interest rate. A general rule of thumb is: the easier a loan is to obtain regardless of your situation, the riskier it is and the more likely it is to come with significantly higher interest rates. In any case, make sure you read all the information contained in your loan agreement. And don’t be afraid to seek advice if you need it. One loan too many, even a small one, is enough to tip you into over-indebtedness. Taking out another loan to pay back existing loans is never a good idea; it only delays the inevitable and exacerbates the problem.

Lastly, keep an eye on authorised overdrafts on your accounts (which often have high interest rates) and be careful how you use your credit card.

• Typical credit cards don’t incur interest, and the balance on the card is always debited after one month. If your account has insufficient funds, the amount will be withdrawn anyway. That will leave you in unauthorised overdraft, which will incur interest.
• The other, less common type of credit card allows you to make deferred payments, i.e. you pay back a portion of the balance at the end of the month, with the rest being staggered over subsequent months. Interest rates on these cards can be high.

Don’t let feelings of embarrassment or shame isolate you or prevent you from seeking professional assistance.

Contact points and information centres

If you ever do become over-indebted, the Ligue and the SICS can provide information and advice. Don’t let feelings of embarrassment or shame isolate you or prevent you from seeking professional assistance. Reaching out is often the first step to solving the problem.

In the majority of cases, over-indebtedness is not the product of fate, but of a conscious decision to live beyond your means. A clear and objective overview of your budget and expenses will tell you whether you can really afford that new car or that expensive coat. If you do take out a loan, make sure you fully understand the repayment terms before committing. Your banker can help you with any information you need, and together you can draw up a realistic financing plan to help you achieve your goals.