You find £1000 stuck under your shoe, do you:
- Add it to your savings account?
- Buy Premium Bonds?
- Put it towards your mortgage?
- Pay off your credit card debt?
And the answer is… 4.
As amazing as it feels to be able to put money in your savings you should always pay off debt first.
When we save we get paid interest on savings, HOWEVER the interest we pay on money we’ve borrowed almost always outweighs this.
If you put that £1000 into a Cash ISA giving you 2.8% interest you’d make £28
BUT if you have a £1000 credit card bill on a 20% interest card you’d lose £200
The Debt Exception:
Student loans: Have such low interest that you shouldn’t rush to pay it off, especially if this means you may have to borrow more expensive credit later on.
The Golden Rule: You should always pay off debt with the highest interest first.It will generally be in the following order:
1. Credit cards – If you have a 0% period on your credit card make sure you are paying enough each month to clear your debt before the interest kicks in. If you want to over-pay you can contact your card provider and ask to increase your monthly direct debit.
2. Loans – If you got your loan after February 2011 you are allowed to overpay by £8,000 in a 12 month period without being penalised. Some banks are still playing catch up with this law, if they do try and charge you direct them to section 94 of the Consumer Credit Act. You need to give the lender written notice (by email is fine) and then overpay within 28 days of giving the notice. The same rules apply if you have less than £8,000 left to pay of your loan and want to pay it off completely.
3. Mortgage – If you have no other more expensive debt to clear, and you have some money put aside for emergencies, then paying off some of your mortgage is an option. You will need to check your contract to ensure you lender is one of the many that allow up to a 10% overpayment without fees. Check when your interest is calculated, if it’s annual and that date has passed then you should put your money into a high rate savings account to earn interest off it until closer to the calculation date. And make sure you have the best mortgage deal as well- if you can switch it could slash your interest payments.