Which loan to clear first?

johngc

My wife and I bought a house to renovate two years ago (for us to live in, not as property developers). We bought the house for £85k, taking out an £80k mortgage and a £20k loan with the RBS to pay for the renovations etc. The loan was over 20 years and at 8.9% but we had always planned to remortgage once the house was finished and clear it.

We are now in a situation where we have re mortaged (and very pleased to find we made a little bit of money on the house ), and will have about £19.5k spare which we were going to use to clear the RBS loan.

However, I have been thinking (not always a good thing) about clearing some smaller debts first and then having more money to throw at the RBS loan payments and so clear it off earlier. Our situation is as follows:

Debt ......Balance ......Payment ......Months......APR

Loan 1......10700...........300.........48.......6.9%
Loan 2......1400............120.........12.......7.8%
Loan 3......1500............120.........12.......2.4%(student loan)
Loan 4......3218............168.........36.......7.5%
C/Card......1280 ...........25..........?.........15.94%
O/Draft.....1613.............?.......... ?.........18.7% (AER)

RBS..........18500..........190..........216.......(8.9%)

As you can see, we have managed to build up a bit of debt over the years and are trying to get rid of it. We both have ok jobs and can cover the bills.

We are currently paying in the region of £940 a month to these debts and the original plan was to clear the RBS and one of the smaller loans with what was left. The money saved monthly would then go on one of the other smaller ones. Oh, I should add that the monthly payments for the old mortgage plus the RBS loan are about the same as the new mortgage. (shorter overall term though)

I am now thinking of clearing loans 1-4 and the c/card thus freeing up around £700 a month which can all or partly go on the RBS payments and dramatically reduce its life.

Is this a sensible thing to do or am I getting the sums wrong somewhere?

gizfizz

i'm a newbie so i'm probably completely wrong
i would clear off your 4 loans and credit card, leaving £1100.
this could then go to paying back the overdraft. you would be £400 in your overdraft with the £18500 rbs loan and saving yourself £733 a month.
in the first month of having the £733 extra you could then pay off the rest of the overdraft (dont forget to lower the limit otherwise its too easy to use it again!) and use all your extra money to load onto the rbs loan until its gone!
that of course relies on rbs letting you make overpayments which i assume you can from what you're saying.
if you know what interest rates all the loans are etc that would probably help others to give advice too

hope this helps, like i said i'm a newbie so no expert

johngc

Thanks for the reply and suggestion. I have added the apr's above.

CLAPTON

if the loans are flexible and there are no drawbacks to making overpayments or early settlement (all probably not true) then its best to pay off the debts with the highest APR.

so clear CC at 18% is a no brainer
and keeping the student loan at 2.4% (but going up soon perhaps to 4.8%?) is also sensible.
so it looks best to clear the RBS although if you want to completely clear it you may have to delay clearing the CC but you can soon do that once you have that extra 190.

gizfizz

whichever way you do it you should be able to clear them all in less than 2 years! :T use this to help you figure out the best way to do it http://www.whatsthecost.com/snowball.aspx

johngc

I understand what you are all saying about the highest APR first (the values I put above are approximate give or take a few .1% as I am at work and can't remember the exact %), and I have always agreed with that, however if I clear the RBS first it will still take a long time to clear the other loans with what is left.

If I say clear the RBS and Loan 2, that will free up £120 a month. That could be added to Loan 4 which would effectivley half the time left to pay, so in say 18 months I would then have an extra £288 spare. Add this to the Loan 1 payment and that would make it £588 a month and pay it off in about two years. By this time, I am sure that any overtime or extra that we might have each month will have cleared the O/D and we would then clear the student loan in a couple of months. All in all that makes about 3 1/2 to 4 years to be clear.

However, if I clear Loans 1 - 4 and the C/C, that frees up the £733 a month. Add that to the £190 and thats £923 a month to the RBS, which by my sums will let us clear it in about 2 years, plus we will have the advantage that if anything happens (car breaks down etc), we can reduce our monthly payment by up to £733. The same as above can be said in relation to the overdraft. This way I seem to be able to clear everything in around 2 - 2 1/2 years.

I am no financial expert (clearly - looking at the state of my finances!) so if I have made some glaring omission or miscalculation, please tell me.

johngc

Gizfizz - you must have been typing at the same time as me, Ill have a look at the link now. Thanks!

Gemmadm

Hi if it was me, I would pay the highest loan first (RBS) as it is easier to pay off lots of smaller loans than 1 large one. Then you can start knocking off the smaller ones (highest apr first) bit by bit. Good luck with what you decide to do.
Gemxx

johngc

Ive updated the APR / EAR's and tweaked a few of the balances as they were slightly wrong. Just realised the O/D is costing us £25 a month! Plus Loan 2, which is with the same bank as the O/D is one where all the interest was added up front and as a result, paying it off early won't save us a penny. :mad:

Ive discussed it with my OH and think that the psychological factor will be a lot better for us and we are going to go with Loans 1-4 and the c/c first. (We both worked a Bank Holiday this month too which I forgot about, so should be able to clear the O/D as well ).

I am still playing with my sums and keep managing to prove to myself that by paying them off this way will be better for us.

Thanks for all the advice though.

johngc

I appreciate what you are saying but by my calculations (post 7) I do save the most money doing it my way - That is I pay everything off about 2 years sooner than just doing the highest APR. The difference in the APR is not so great that I will be paying so much more in those 2 years in interest.

By going at the many rather than in strict APR order, I will still clear the highest ones (C/C and OD and Loan 4) first anyway. That will leave me with all of RBS at 8.9% against the same ammount of debt at a mixture of between 8.9% and 6.9%. The difference is though that I will have a higher ammount of money to put at the RBS all in one go rather than increasing payments bit by bit as the smaller loans get cleared.

johngc

Ok, my workings out (now I have spent some time I can see that the above working by me are a bit out):

Option 1 - Highest APR first

Pay off C/C, O/D and 16807 of the RBS Loan (Just got my cheque from the remortgage and I have 19.7k to use)

That leaves £1693 of RBS. Add the £100 a month that I would be saving from the C/C and O/D and thats £240 a month and the RBS would be gone in 7 months.

So in 7 months time I attack Loan 2, which is now down to £775. I throw £360 a month at it and it is gone in 3 months.

So in 10 months time I go at Loan 4, now standing at £1223. I have £518 a month to use and it is paid off in 3 months.

13 months in and Loan 3 would have cleared its self with the normal payments. I now have £938 to put at Loan 1, which is by now £7208. That would take 8 months to clear.

So 21 months down the line and I am debt free (not including the mortgage)

Option 2 - Smallest ones first

Pay off all bar the RBS (ok, I am £11 short)

That gives me £948 to pay against it each month, and it wil be cleared by Jan 09. Which is 21 months.


I don't underrstand how it can cost me more when each debt is cleared at the same time?

Oh, and the I have just started a 2 year fixed with A&L at 5.74%