It all just got serious

BrotherUuurgh

Hello, long-time-since user and lurker of the forum. The situation I find myself in needs attention so I decided to come back. 

I plan on starting a diary to chronicle the journey to becoming debt free (the proper way this time) and posting my SOA to see whether it's possible to reduce outgoings. I guess I just wanted to say hello.

To begin, my total debt is approx £14,500. I have two loans, two credit cards, and two family debts. I have the exact numbers for these on paper but for the purposes of this post I'll be brief. I have a question regarding one of my loan accounts: Will I both save interest and clear the debt sooner by making over/extra payments? When I view the Key Facts document associated with this account, it says it is a fixed sum loan agreement, however when I log on to my account, it says that making overpayments will save me interest and clear the debt quicker. I thought this is how CCs work but no loans. There seems to be a contradiction here, no? What is the actual real world answer?

CliveOfIndia

Yes, making overpayments will clear the loan quicker and mean you pay less interest overall.  Just read the T&Cs to make sure there are no penalties for making overpayments. For a standard personal loan it's common for them to impose an early settlement penalty of up to 2-months interest if you repay the loan completely, but usually there's no penalty for making overpayments.  But do check the T&Cs just to make sure.

But in terms of saving the most money, you need to throw any spare cash you have at the debt with the highest APR.  I'd hazard a guess that your credit cards will be more expensive than a personal loan, unless they're on a low- or zero-percent promotional rate.  But again, do check to see what the APRs of all your debts are - then prioritise the one with the highest APR.

Andyjflet

I think.... that the loan has to be recalculated each time an overpayment comes in, therefore the principle balance is lower making the interest calculation lower, could be wrong. 

When I was paying off debt I used the snowball method, smallest to largest, its a proven method, regardless of interest. 

CliveOfIndia

Andyjflet said:

When I was paying off debt I used the snowball method, smallest to largest, its a proven method, regardless of interest. 

The snowball method works for a lot of people.  You do tend to see results quicker, and there's no question that you get a big psychological boost from seeing a particular debt disappear completely.  But purely in terms of cold hard cash, hitting the highest-rate debt is the better approach (assuming no fees or penalties for over-payment).

The approach that works best for one person may not necessarily work for everyone

Andyjflet said:

I think.... that the loan has to be recalculated each time an overpayment comes in, therefore the principle balance is lower making the interest calculation lower, could be wrong. 

That's it in a nutshell.  Each monthly payment you make pays off the interest for that month, plus a bit of the principal.  Gradually over time, as the principal decreases, so the amount of interest you're charged also goes down.

If you make an additional overpayment then your "scheduled" monthly payment pays off that month's interest and a bit of principal, but your additional overpayment all goes toward the principal.  So next month the principal is less than it would have been had you only made your contractual payment, therefore you're charged less interest.

ManyWays

It is often best to use any extra money to clear credit card debt, not only is it simpler, the interest rate is usually much higher so you save more, and it also helps improve your credit score which can make it easier to sort out the remaining debts. 

CliveOfIndia

ManyWays said:

and it also helps improve your credit score

Except that your credit score means absolutely nothing, it's not even seen by lenders.

When assessing your status, one major factor than any lender will take into consideration is your overall level of existing debt.  It's largely irrelevant in their eyes where that debt is sitting.

Yes, you're absolutely right that credit cards, on the whole, tend to be among the more expensive forms of debt, and it does make financial sense to prioritise the highest-rate debt.  But the score you see on your credit report can be safely ignored.