In our Budgeting Clinic series, Tom Francis, head of personal finance at Octopus Money, answers your questions about all things personal finance. Tom is a fully qualified and chartered financial planner. Worried about how your savings are shaping up for the future, or need a plan for how to get out of debt? Drop him an email on money@theipaper.com.
Question: After a stressful and drawn out situation moving flat last year I have ended up with around £3,000 of credit card debt. It’s on a rewards card and the interest is fairly hefty if you don’t repay each month. I’m currently paying the minimum amount each month towards it as I don’t have enough from my day to day wage to pay it off. However, I do have a savings account with around £5,000 in, but this is a fixed bond and I can’t access it yet. If I do, I lose all the interest I’ve gained and it’s a rate of about 6 per cent. How do I decide whether it’s worth biting the bullet, and are there any alternative options for the debt? What should I be weighing up?
Answer: First off, I am really sorry to hear about the ordeals of moving home that you have faced over the past year. Moving property throws up some of the most common challenges when it comes to our money.
Whether it’s surprise extra removals costs, struggles to get back a deposit on a rental property, or last-minute changes to move-in dates that leave you out of pocket, moving property is a stressful and costly experience.
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I am sorry that this has resulted in you needing to resort to credit card debt to cover the costs of what sounds like a complicated and unexpected situation.
As a quick aside, it’s moments like these that reminds us that our finances need to flex to support our lives. It’s not always possible to predict the surprise challenges and pitfalls that are around the corner, it’s not always easy to strictly stick to a financial plan or to budget for them either.
It can sound easy to apply rigid-sounding rules to money and planning, but we forget that the whole point of saving and budgeting is to enable us to live the lives we want, in the location we want – and to give us the peace of mind that we have a financial buffer to cover us in the event of the unexpected.
Firstly, let’s discuss how to address your current dilemma. There are two key considerations.
Securing your current position
While it might feel like the priority right now is potentially paying off debt, it’s vital that you zoom out slightly, and consider your life over the next three to six months.
As recent history has shown, life has a habit of throwing up unexpected costs, and there is little point paying off debt, only to find yourself needing to take on more very quickly, due to a lack of available cash to cover your day to day expenses.
Therefore, it’s important you keep access to some of your savings. We call this a rainy day fund, and it often makes sense to try and keep up to three months worth of your outgoings in an accessible bank account. You haven’t mentioned any other savings outside of the fixed bond, so if there aren’t any, it’s important that you earmark some for your rainy day fund.
Even though you will likely need to place this in a savings account that has a much lower interest rate than your fixed bond account to make sure it is instantly accessible, the lower growth rate is worth it to make sure you don’t need to resort to a credit card to cover any future bumps in the road.
Think of this money as a safety net, and it often helps us sleep slightly easier at night knowing it’s there.
Tackling your debt head on
Once you have this, it’s on to your question of whether to sacrifice the interest that you have accrued on your fixed bond savings to pay off the credit card debt.
This is where maths comes in. You can think about the option of paying off debt as a guaranteed rate of return. We know that your credit card debt is accruing interest right now, and will continue to until it is paid off.
We also know that your savings bond is currently earning interest at 6 per cent. If your debt is accruing interest at a rate that is higher than 6 per cent (often credit cards can charge around 20 per cent to 30 per cent), then it could well make sense to pay down some of this, even if it means missing out on the savings interest you are earning.
Put simply, if your debt is growing quicker than your savings, then paying some of this down can be a valid option.
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A potential alternative could be to search for an interest free credit card. This would enable you to balance transfer the existing amount that you owe on your rewards credit card, which you said has a hefty interest rate, and move it over to a card that will not accrue interest until after your savings bond matures, if you can get the timings to align.
This way, you avoid accruing interest now, benefit from getting the interest you have earned on your savings and can use that money to pay off the credit card debt later.
Of course, this would all be subject to getting approved for one of these cards, which depends on your specific financial circumstances.
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