When is it ok to use my savings to clear debt?

Is it OK for me to stop saving and pay off my debt?

That is a question that I see being asked quite a lot around forums and blogs about money. So to clarify the situation, the answer, here at the Smart Wallet HQ is an unequivocal and absolute YES. Get rid of any savings and pay off your debts. Go. Do it now, I'll wait until you return.

I can say this with certainty, because you stand to save more by doing this. Stop right there, first I'm told that saving is the key to good finances, and now that I have some savings you want me to stop saving and use it? Yes. Debts cost more than savings, clear it off and your finances are better off.

Lets get some things cleared. A credit is a positive addition to your net worth, like when my business pays me at the end of the month. I now have a net credit worthiness of say £2000, which means that I am now worth £2000 more than I was, 24 hours earlier.

A debt is the opposite of credit, in fact it is negative credit. If I have a debt of £1000, I am now worth £1000 less, because sooner or later, I will have to pay that money back. It is easy to calculate your net worth this way. Just add up all of your positive credits (house, car, laptop, jewelry) and then subtract all of your negative credits (credit card balances, loans, mortgages). Your OK when the sum is positive, but when it is not, then you need to start rethinking your finances.

The problem compounds because of, well... compound interest. Your £1000 negative credit can easily spiral to several times that. (Assuming a 35% APR on a credit card balance of £1000, after 1 month it will be £1029, after 2 months £1159, and after 12 months £1411).

And to add to our woes, the credit lenders are like casinos, the house always win. The debt interest rate will always beat any savings rate they provide. So if you borrow £1000, and put it into a savings account - you will lose. The savings will be paltry, compared to what you have to pay back in interest.

Ok, lets crunch some numbers. Lets assume you have a debt of £10000, with a modest 15% APR. This could be a car on finance or a personal unsecured loan. And lets say you have savings of £5000 earning 5% interest (yeah, right - that's not very easy to get, most banks pay you peanuts on your savings).

So your net worth is £5000 (without calculating for next months salary), and assuming no extra income/outgoings, your net worth is going to be as shown in the table below.

The only winning move is not to play.

	-ve Credits	+ve Credits	Total
Current Month	-10,000	+5,000	-5,000
Month 2	-10,125	+5,020	-5,105
Month 3	-10,251	+5,041	-5,210
Month 4	-10,379	+5,062	-5,317

As you can see it is a fools game. You cannot win. Your savings will never outweigh your debts. And your net worth is spiraling further and further into the negative.

Now assuming that you use your savings to pay off the debt, here is another simulation:

	-ve Credits	+ve Credits	Total
Current Month	-10,000	+5,000	-5,000
Month 2	-5,062	+0	-5,062
Month 3	-5,125	+0	-5,125
Month 4	-5,189	+0	-5,189

There is some light at the end of the tunnel, your net worth is a lot better in this scenario than in the previous one. Just after 4 months, your £128 better off than if you left your money in savings. 

So, there you have it. While my theoretical simulations above may not represent your current financial circumstances accurately, it should give you a base for doing your own napkin calculations (if your inclined that way, I would recommend a good free spreadsheet, like google docs). Your always guaranteed to save more for your future self by paying down debts now.

There are specific cases, like my pre-2012 student loan, that incurs 0.0145% interest, which is beaten by my 0.018% savings in my emergency fund.

There are certain factors to take into account, the first and foremost is to pay off the most expensive debt first. This will be payday loans (why you have those is beyond me!), store cards (again, why?!), credit cards (a bit better, but still shop around for good deals, and money making schemes), as opposed to the mortgage, or a student load or a cheap personal loan - which provide 'cheaper' interest rates.

Consideration should also be given to a consolidation of loans. This will generally require speaking to someone face to face or over the phone, but it might help to reduce your costs and repayments (and credit score) by having to make a single repayment instead of 3 or more per month. You might also be able to use credit cards to your advantage, by shifting the balances of several cards to a long 0% deal. Sometimes, just asking politely, you might get a reduction of the rates on your debts too.

Thirdly, look out for the small print. Common sense would dictate, that a lender would be happy to accept early repayment, as they are getting their money back and can use it elsewhere. But no, despite the fancy 3 piece suit your banker wears, he only does it to hide his dorsal fins and other shark like traits. There are a whole host of fees and penalties that a lender can charge you for early repayment. And in some cases, this might be the same as the interest they expect you to incur over the loan term, so you might be better off in that scenario, saving your money and slugging off the repayments as expected. Some mortgages, do allow a small percentage of penalty free over payment per year - if you can do that, do it.

Finally, don't forget to keep an accessible liquid emergency cash fund. Life can throw anything at you at anytime, from a burst drainage pipe to a broken boiler. It makes sense to pay off expensive loans/debts and should you need emergency cash, you can reborrow on a credit card and pay off the card within 30 days - but if getting a credit card is difficult or the rates are horrendous or you need the cash for longer than the 30 days interest free period, an emergency cash fund is important. For example, a cheap mortgage might mean you can use all your savings to overpay, but keep £1000 for emergencies. Or you might choose to spend all your savings overpaying the mortgage, knowing that you have a few thousand £ limit on a credit card. But should you have a 35% APR credit card loan, throw all your savings at that, and you can always reborrow from the card later should you need to. This will vary based on your circumstances, so will require some thought on your part.

That concludes my thoughts on debts vs savings. I hope that this piece encourages you to think about where your money will make the most impact (paying off debts), and hopefully it saves you some money in the long run too. Adios. 

The NISA's have landed!

July the 1st marked the date when the UK government upped the Cash ISA limit to a whopping £15,000, up from the previous £5760. And that's not all, you can now decide to invest the whole amount in either cash or in stocks or any combination of the two. They have now been named NISA (New Individual Savings Account).

Junior ISA’s (JISA) have also upped their limit to £4000.

This is a radical change from previous years, where your cash ISA was limited to £11,880, and only half could be held in cash and the rest HAD to be in stocks and shares or you could have had all of it in stocks and shares.

My recommendation is to locate a good ISA account, and fill this up to the max as soon as possible, to ensure the best returns for your money.

What is a NISA?

It is a savings account, in which you do not pay any tax on the returns. Every other type of investment in the UK, once you claim your profit, requires you to pay the tax-man his share. If you invest in shares and stocks, your dividends and profits are taxable after your salary. If you run a business buying and selling cars, the returns are taxable. If you earn interest from your current account or a savings account - the returns are taxable.

A NISA account protects your returns from the taxman. No matter how much you earn, the taxman does not get a slice of the pie. Nothing at all. Regardless of how much you earn and what tax threshold you fall under and how much National Insurance you pay, your NISA earnings are yours to keep.

So a savings account that gives you a £100 return, is only worth £80 to you after you pay 20% tax (if your on the lower threshold, obviously if your on the higher tax threshold, you pay 40% tax and only get £60 back). A NISA that earns £100, lets you keep £100.

How do they work?

Each year you are given a limit (it is £15000 for adults for April 2014-2015), you can put up to that much, in any number of NISA accounts with any number of banks. It is completely up to you, how you split it up. There are 2 types of NISA accounts available, Cash NISA and stocks & shares ISA. Previously there were limits imposed on how much cash you put in. This limit has now been removed.

You can open up both types of ISA’s. And invest your £15K limit 50/50 (or 20/80 or any other combination - as long as you don't exceed £15K in total) to reduce some risks. You can completely forgo the shares if you don't want any risk and just put £15K into a cash ISA and reap the lower % rewards. Or you can go guns blazing and invest in a shares ISA for maximum returns (and maximum risk, as stock prices do drop sometimes).

The NISA will continue to pay returns on this account year after year, as long as you do not close the account. The returns paid are cumulative, so in the first year from a 3% NISA, if you invest £15K you earn £456.23, in the second year that same account pays £470.12 and so on. If you have a partner or a spouse, you can double that (by opening 2 accounts, one for each).

The only limit imposed is that £15K limit. Any withdrawal also cuts into the £15K limits. So if you say, put in £14K (you only have £1K left of your limit), then withdraw £2K (for a luxury cruise trip), your limit is still £1K - the withdrawal does not increase your limit. So if you can, avoid withdrawing from NISA’s, have a contingency fund elsewhere.

Also you're able to switch your NISA provider (anytime during the financial year or afterwards), if they change the returns rate, or if you find a better deal elsewhere; But you must fill in a transfer form and get it transferred, DO NOT withdraw the cash, and open a new account elsewhere. A new NISA account eats up your cash limit for the current year.

For example, if I had invested £3000 a few years ago in the old ISA and wanted to switch to a higher rewarding NISA account, if I withdraw that cash and put it into a new NISA account. I lose £3K of this years £15K limit. If I transfer that old account, to the a new account, I still have my £15K limit for this year.

Some NISA accounts also have a very slow withdrawal rate (120 days in some cases to access your money), and some of them will penalize your returns if you withdraw from an account you have opened in the last 12 months. Read the small print - but in most cases, I find that the penalties and low access, are acceptable, as the returns are still greater than the paltry 0.01% a current account pays (and then you get taxed on that too).

Finally once the financial year has ended, you are no longer able to add (you can still withdraw your cash) to the NISA for that year. A new £15K limit will be imposed and you can open up a new NISA for the next year.

So from 5th April 2014 to April 2015, you can invest £15K. If you do not use up your £15K limit by 5th April 2015, you cannot add to that account any more. But you can open up a NISA for the April 2015-2016 financial year, and that year will give you a new £15K limit (this depends on the government, they usually increase the limit as inflation rate increases). This limit is not tied into an account or a bank, it is tied to a person, you, and applies between april of one year and the next. After which a fresh new limit starts. Any money you save this year continues to gain returns. Hence why I strongly urge you to use up as much of this limit as is possible, before the start of the new financial year. Obviously withdrawal from the account removes that tax-free shield it has. A 3 year old ISA will continue to be tax-free until you take the money out and put it into a savings account or something. Sadly, you cannot top up that old account any more. So again, I urge you to try and leave old ISA’s alone, and let them accumulate.

How to maximise profits

Kill off debts. Most lenders charge a higher amount of interest on debts than a NISA can return. A £100 debt on a credit card will leave your bank balance -£134 at 34% APR. A payday loan, pfft  -£200 or more. An overdraft or personal loan of £100 at 5% will leave your bank balance at -£105, once paid back. The tax free NISA gains on a £100 at 3%  will give your account £103 at the end of the year. Use the money to pay off your debts first or your returns from your NISA will be wiped out.

Siphon the money into a NISA as soon as possible. Most people only wait until the end of the financial year, near the deadline for the year end, as they accumulate cash in their current account, before investing in a cash NISA. This wastes valuable tax free savings, and the only entity that benefits from this is your bank, as your current account probably does not beat the returns of a good NISA. If you invest a month prior to the deadline, £15000 will get you £37.5 tax free returns, for the year. Invest at the start of the year, and you will accumulate £456 tax free savings. If you drip feed the account from your salary, you will still reap more benefits than a lump sum at the end of the year.

Play the banks. Savings in current accounts are generally quite good, with Santander paying up to 3% on sums of up to £15K, for earnings of £564.23 for the year - but don't forget that the returns are taxable, leaving you with £364.98.

Nationwide FlexDirect, though pays 5% on sums of up to £2,500, so that £2500 would earn £75 in a cash NISA, but  £125 at nationwide, which amounts to £100 after 20% tax. Its worth £75 after 40% tax. So it could be an extension to your £15K cash NISA limit, as it still beats most of the other accounts out there. Also a current account gives you access to your money instantaneously. I recommend utilising both.

Do not withdraw. If you decide to withdraw from your NISA, the amount you withdraw is not taxable. So your £15,000 NISA will give you £15,456.23 after one year, but once taken out of the NISA and sitting in your bank account returns you get from your bank are now taxable. So if you're planning a holiday or buying a house and need cash, do not withdraw earlier than you need to as you lose the tax free earnings (think £30 or £40 lost out on, if you withdraw a month earlier than you need the cash).

Keep an eye on your old (N)ISA accounts. Banks may change their return rates, and may have ‘forgotten’ to let you know or you may not have read that letter they sent you. If rates drop, transfer the account, as soon as possible.

Consolidate old ISA accounts. Another tip, not to maximise profit, but to save you some time (time is money, afterall), you are able to consolidate your previous NISA accounts into one. This lets them all share the same returns rate and also lets you keep an eye on them from one online account, or a single telephone call, as opposed to having to log in multiple times to multiple accounts to check balances and rates of returns. Discuss this with your banks and they can consolidate all old accounts in one place.