I want to get out of debt — my friends say I should stick to minimum repayments

It’s sometimes difficult to know who to believe (Picture: Getty Images)

When it comes to money, people have a range of different outlooks, from Financial Independence and Retiring Early (FIRE) to ‘spend now and deal with the consequences later’.

And this can lead to them offering conflicting (and often unsound) advice — as Metro reader Sean, from Colchester, is currently finding out.

When the 38-year-old spoke to friends about his plans to ‘aggressively’ pay off credit card debt, they weren’t convinced it was a good idea, instead recommending he focus on investments.

In this week’s Money Problem, personal finance journalist and consumer champion, Sarah Davidson, helps Sean cut through the noise.

The problem…

I’m in two minds about whether to tackle my debt aggressively or just chip away slowly.

I’ve got a £3,200 credit card balance at 19% interest (from a mix of car repairs, moving costs and, honestly, a few nights out I couldn’t afford). I also owe £9,000 on my student loan.

I can cover minimum repayments easily, but I’d love to clear the card ASAP. At the same time, friends keep saying I should put spare cash into savings or investing rather than ‘throwing it all at debt’.

My head spins trying to work out the smartest move. Should I focus everything on the credit card, balance paying it off with saving, or not worry so much?

The advice…

Your instincts are correct, Sean. Deal with the debt first and then start saving.

It’s important to recognise though, that you have two different types of debt and the same rules don’t apply to both.

First, let’s look at the credit card.

You say you’re making the minimum payments each month. Usually, the minimum payment is calculated as a percentage of the total amount you owe plus interest and any fees, like late payment charges. It depends on your provider, but most charge between 1% and 3% of the outstanding balance or a minimum payment of £5 to £25 a month, whichever is higher.

You’ve got £3,200 outstanding so, based on a 2.5% rate, your minimum payment is likely to be around £80 a month. Of that, around £50 is interest so you’re only paying down the debt by £30. If you keep making the minimum payment only and don’t spend anything further on the card, you’ll be paying this off for the next 14 years and you’ll have handed over £3,496 in interest for the privilege of borrowing £3,200.

You’ve said you can cover the minimum easily, so if you were able to afford to, doubling that payment from £80 a month to £160 would mean you would clear the debt in just over five years and pay £1,641 in interest.

That’s a saving of £1,855 that you could put to use elsewhere – either sticking it into a cash savings account or investing it.

Credit card interest can really rack up (Picture: Getty Images/Westend61)

Second, the student loan.

This type of debt is an odd one because it doesn’t operate in the same way as any other loan or credit card. With student loans, you repay plus interest only if or when you can afford to, and the interest rate is set at inflation. In theory, that means the outstanding loan isn’t getting bigger in real terms – a fancy way of saying £100 today will buy what you could have bought for £95 this time last year.

It’s worth saying that student loan repayments only kick in when you earn more than £26,065 a year (£2,172 a month), then you pay 9% of what you earn over that. It’s taken out of your pay packet automatically, so long as you tell your employer.

Clearing this debt early is up to you and what you can afford, Sean. But I would say that it’s not the same as having a credit card or personal loan of £9,000. Yes, you’ll pay more interest over time but you won’t be paying such a punitive rate. Plus, if your income falls, you won’t have to keep making repayments until you can afford to.

Thirdly, your friends’ suggestions that you put spare money into savings or investments are savvy – it’s just the order in which you approach things.

The best easy access cash savings account at the moment is Cahoot Sunny Day Saver, paying 5% on balances between £1 and £3,000. If you were to put £100 in that today, you’d have £105 in 12 months’ time.

Investing is unpredictable as the price of shares and other assets change depending on a huge range of factors. Politics, business confidence, tax policies – these can wipe out the value of investments overnight or see you double your money.

This is why investing should be looked at as time in the market, not timing the market. Over a period of five years, it’s likely that the lumps and bumps that move the value of investments up and down daily will smooth out. On average markets rise over time, with that uplift around 5% a year over the past 20 years.

It’s important to do the maths (Picture: Getty Images)

In answer to your overall question, should you clear the credit card first, pay it off slowly and save a bit at the same time or stop worrying, it’s simplest to do the maths.

You’re paying 19% on the debt, cash savings would net you at best 5% and investing (which should be done only with money you can afford to lose and that you don’t need to access for a minimum of three years, more safely five) is likely to get you around 5%.

When weighing up how to prioritise financial decisions, take the interest rates and put them side by side. The first thing to do is tackle the biggest number – in your case 19%. If your student loan was with a bank and you were paying 9%, that would come second. Then, at 5%, the savings and investments come last.

For context, we can turn this the other way around. If you were paying 2% interest on a mortgage, let’s say, but you could earn 5% in a cash savings account then you could argue you’d be better off saving and then using the interest you’ve earnt to pay off the mortgage afterwards.

With all of this, bear in mind that circumstances change and you may have to flex accordingly. But on balance, I’d suggest paying off your credit card as fast as possible first and then start saving.

You could put half of what you can afford into a cash savings account and half into an investment Isa, which would give you the security of being able to access cash if you need it while also benefitting from the potential that investing long-term offers.

Sarah Davidson is an award-winning financial editor and head of research at WPB.

Got a money worry or dilemma? Email [email protected]

What do you think Sean should do?