Reducing the cost of debt (I)

Whilst most people will have some sort of debt to manage their finances, the aim with debt should always be to repay it as quickly as possible whilst paying the least amount of interest along the way.

Here are eight tips to help reduce the cost of your debt.

Tip 1: Move credit card balances to a 0% interest credit card

If you have credit card debt, it is worth shopping around to see if you can transfer the balance to a new 0% interest rate credit card. Some credit card companies are currently offering more than 2 years at 0% interest and, even though they usually charge a fee for transferring a balance to them, it is still generally worth doing to reduce fees overall. It may also be possible to transfer non-credit card debt to a 0% interest credit card so, if you have other debt, consider moving it across too and save on the interest you are currently being charged.

Consider cancelling old credit cards when you have moved their balances across and use the 0% period to pay off as much of your debt as possible. Otherwise, when the 0% interest period ends, your cost of debt will increase.

Tip 2: Pay more than the monthly minimum payment on your credit card

Whilst it may be tempting to only pay the minimum amount on a credit card each month, you should consider paying more if you can.

Paying the minimum payment simply ensures your debt will take longer to repay and, as a result, you will pay far more interest on your credit card debt than you otherwise would.

Take, for example, a standard credit card with an annual interest rate of 19.9%. If you have a £3,000 balance and only pay the minimum payment each month, it will take you more than 25 years to pay off the debt and you will pay an eyewatering £4,000+ in interest along the way! By contrast, if you were to pay £80 per month, every month, the £3,000 debt would be cleared in less than five years and you will pay around £1,500 in interest.

Anything you pay above the minimum payment will help reduce the time and costs of repaying a credit card debt, so work out an amount you can afford to pay each month that is above the minimum payment and pay it. The more you pay, the more you will save in the long term and the quicker the debt will be cleared.

Tip 3: Use savings to pay off debt

Whilst it’s nice to have an emergency fund (as a rule of thumb, that means enough saved to cover your essential spending for the next three to six months), interest rates on savings are at an all-time low and far lower than the interest charged on most debt.

As a result, if you have savings over and above your emergency fund, consider using the savings to pay off all, or part, of your debts, as it will save you money.

Focus first on repaying debts that charge the highest rate of interest, such as bank overdrafts, store cards and unsecured loans, but always check first that overpaying or repaying a debt early won’t attract any sort of financial penalty (mortgages in a fixed rate period, for example, tend to incur charges if you repay them early or overpay them beyond a certain level).

If you have managed to move debt to a 0% interest credit card, then it is probably financially more beneficial to keep your money in savings and earn whatever interest you can. However, not having debt is a nice position to be in, so consider what is more important to you – would you prefer to have no debt, or to have debt and cash in the bank.

Tip 4: Re-mortgage to get a better deal

Whilst mortgages are generally a long-term commitment, that doesn’t mean you need to stay with the same lender throughout. Over the past few years, interest rates have reduced considerably and there are mortgage interest rates currently available which are dramatically lower than they were just four or five years ago.

Over time, you can also become a more desirable customer to lenders as several factors determine the interest rate a mortgage lender will be willing to charge you for your mortgage. This includes your earnings increasing, but also the difference between what you owe on your mortgage and the value of your property (the Loan to Value ratio).

As your loan to value ratio becomes smaller, either through slowly paying your mortgage off or the value of your property increasing (which has been the case for a lot of people over the last few years as property prices have risen steadily), better deals can become available.
So, if you have had a mortgage for a while, you are coming to the end of a fixed-rate deal, or you are currently paying your lenders’ standard variable interest rate, it is worth looking at whether you can remortgage, as you could reduce your monthly payments and save thousands of pounds over the lifetime of the mortgage.