Beware monthly repayments, they're really a loan!

Ah, is it time to renew you insurance? Are you buying a new mobile phone, washing machine, TV, vehicle or any other expensive item? or perhaps you are repaying a credit card purchase? The financial experts behind these services are really helpful - they do not want you to go through any hardships with your daily dose of visual entertainment on the TV. They'll even throw in free next day delivery in most cases.

Why settle for a 40" dumb TV with a plain old HD LED screen, when you can have 58" 4K TV with built in free view, smart remote, wifi capabilities, media streaming with a propriety interface and badly designed remote (that takes forever to type anything into the badly coded web browser) and mediocre version of BBC iPlayer / YouTube apps built in - that will update for 6 months and then stop. Surely the latter is the better option?

It really isn't better at all in my opinion - a TV built with all of those features, still feels underrated compared to a TV attached to a small energy efficient PC. It has the streaming, WiFi, free view, decent keyboard, latest software updates, Google Chrome, YouTube and pretty much every feature a PC has, on a giant TV screen! Plus a small Bluetooth or wife remote with a reduced sized keyboard is plenty good for that setup.) Unfortunately, despite my proposed solution being better than the latest in Smart TV technology, both still provide access to mind numbingly stupid TV content - which we are all more than happy to consume. There appears to be no known cure to this willingness to succumb to 'reality' TV shows and other stupid content, so far - bar the removal of the TV or very strong will power, and only watching a documentaries or insightful content every now and again; The latter has served me well.

In any case, I will rant about TV content and modern media another time, in the meantime I want to make those sales sharks people the core of our discussion. In particular their suggestion of repayment over the long term. It sounds like a very helpful proposition, "the buyer cannot afford, £1000, so we let them pay this amount over 48 months". Here is the sting in the tail: "with interest".

See the image below, for car insurance

See the 3rd column? With installments? You are paying back the loan with interest and the total repayment is xxx amount - more than the figure shown in big lettering. This applies to almost any sort of repayment strategy. Buying a £1000 TV with monthly repayments, is effectively a loan for £1000 - at a very high interest rate, which you pay back. 

The same applies for a mobile contract, if you look at a SIM only deal, you can see talk time is cheap (600 minutes a month, is 10 hours of talking!), so why pay £20 to £40 a month? In reality you are paying for the handset, which when you total the length of the contract, will easily end up in the £1000's - just for owning a bit of metal/glass and plastic - which I assure you, before your contract comes to an end, is going to be a burden on you (slow, laggy, buggy, scratched/damaged) - and you will be itching for the next new phone. You could buy even the most high end handset for half of that price, and put a monthly SIM card in there, for £10 or less.
Monthly repayments really are a loan, I do not need any further examples.


So what is the solution to this predicament?

1. Do not buy crap, you will find your life is pretty complete with a smaller, less featured model of this item. (obviously car insurance or home insurance leaves us little choice). Even if you can afford crap, carefully evaluate this crap and then decide if you really need it.
2. Do not buy crap you cannot afford. Save up and then buy it outright - you might get lucky and see a price reduction/sale over the next few months and also not have to pay the interest - savings galore!
3. Talk to a human being on the phone and arrange an interest free payment option spread out over 2 or 3 months. That should reduce the sting of having to fork out £2000 or whatever in one go, and instead spread it out over 3 months with 0% interest. Not everything is automated, and speaking politely and explaining your circumstances in some cases, may help. I have done this with my car insurance for a few years now, and off course payment was made with a cashback credit card, thereby collecting a nice tidy bit of cash at the end of the year.
4. Borrow cheaply elsewhere. If it is absolutely necessary that you pay for this large expense, get a loan, overdraft, or a credit card with a lower APR than the sales person proposes. Work it out on paper and shop for cheaper lending options.


Research is key. 

In the above insurance example image, the RAC insurance is £2632 paid outright (its a lot of money to pay in one go), and it works out to be £2895 paid monthly, after all installments have been made, a difference of £263 over 12 months. That is almost £22 in interest per month. 

• Can you borrow £2600 elsewhere at a cheaper rate? (i.e. on a 0% credit card or a trustworthy friend/family member, overdraft on your bank account (my bank charges me £12 for overdrafts per month - which is cheaper than the £22 interest I would be paying)).

• Can you dip into your savings? Surely your £2600 savings are not earning you more than £22 a month? in which case it makes sense to let them earn. Otherwise use your savings to pay this cost, as it will save you £263 worth of outgoings at the end of the year - left in savings it will generate far lower. (Hint: you have to earn 10% interest to get £260 returns on £2600 - which is near impossible for average people like you and I).

I honestly believe, we sometimes pay ridiculous amounts for things we could do without, just for the sake of having something new or shiny, be it a TV or a sofa or a new phone. The novelty wears off within a few days, but the (hidden) interest payments continue for a long, long time...

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.