Finance expert was answering a question on his BBC Podcast over using savings for paying off debts or take the interest
Martin Lewis has explained a key credit card rule for all savers – and explained when it would be best to clear debt. The personal finance expert was speaking on his new BBC Podcast this week and answered a question from a listener about the best way to use savings. And he used a rule of £1,000 to explain how it works and show people how they should calculate the benefits.
The caller, Dan asked: “You’ve talked about whether you should pay off any debt before savings and investing. Does this apply to mortgages.” The issue, Mr Lewis said, was whether a person stands to gain more by actually using hte money.
He said: “My general advice about debt is you should always pay off expensive debt before saving. It does get a little bit more contentious because you also want to have an emergency fund.
“It depends on the nature of the debt that you pay off. The emergency fund is there so you don’t have to pay off even more. Credit cards are quite simple because credit cards are an open ending system of borrowing.
“So if you think about it, if you’ve got £1,000 on a credit card and you’ve got £1,000 in savings, the credit card is costing you 20 per cent, the savings are gaining you 4 per cent. You gain 16 per cent if you use the savings to pay off the credit card.
“And the advantage with the credit card is once you pay the credit card off it can sit there at a zero balance and if you have an emergency because you now don’t have any savings you can just borrow back on the credit card and you’d be in no worse a positio but you would have saved the interest meanwhile.”
This would mean that a person with £3,000 on a credit card would face charges of £600, whereas if they had £3,000 in savings nets you £120. On the issue of mortgages he said: “The general rule of thumb is this – if the mortgage rate is higher than the after-tax rate you can earn on savings – so let’s say you’ve got a 6 per cent mortgage and then 4 per cent in savings – then you are generally better to overpay the mortgage, making sure the payments go towards reducing your capital which will effectively reduce the amount of time you have left to pay on the mortgage .
“If the savings rate is higher than the mortgage rate, then you are probably better off to save – with a couple of caveats. First of all I’d go on to a mortgage overpayment calculator because if it’s very close between the two generally overpaying your mortgage will win because of the vagaries of the way interest is worked out.
“But also if you reduce the amount of your mortgage debt, if you’ve got quite a high proportion of borrowing to your house’s value if you reduce the amount of your mortgage’s debt, you reduce the loan to value which could mean you get a cheaper mortgage when you come to remortgaging.
“The two big caveats to overpaying your mortgage are – first of all I’d always have an emergency fund in liquid cash because if you overpay your mortgage and suddenly something happens that you can’t pay it any more, that’s not going to start the bank going ‘oh you’ve overpaid so don’t worry about paying us now’. They’re still going to put you in arrears.
“And second you need to check that there aren’t any overpayment penalties.” He explained that in general mortgages allow people to overpay 10 per cent without penalties. To listen to the full podcast, click here.
