Have a Loan? Here's How to Cut the Cost


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By Crispin Bateman

on Monday 10 June 2019


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Borrowing money is great, isn’t it? Right up to the point where you realise that you have to pay it all back – with interest!

The truth is that personal loans are always going to have a cost associated with them – you get the convenience of the money upfront, but you have to accept those interest rates. All too often, however, you take out a high-interest loan when you need the money (and will agree to whatever rate is asked of you) and then find it a weight to pay back as time goes on.

Thankfully, there are ways to reduce the cost of your loan, including getting a cheaper interest rate to manage it.

Taking control of debt

Option #1 – always use your personal savings

Advantages:

  • Clears loan faster

  • Saves on interest paid

  • Improves credit rating

A lot of people cling on to savings while also covering monthly loan payments, often in the belief that it is important to have those savings protected.

The reality is that doing so can mean you are paying unnecessary interest charges.

In this simplified example – let’s say you have £5,000 in savings generating 2% in interest per year, but that you also have a £3,000 loan at 19% interest.

In a year, you’d earn £100 in interest on your savings, but pay £570 in interest on the loan. That’s a total loss of £470.

If, however, you paid off the loan with the savings, you’d have £2000 in savings (still generating 2%) and £0 in loans. At the end of the year, you’d gain £40 in earned interest, making you £510 better off than if you’d held onto those savings.

There really is no merit at all in holding onto savings while you have debt – it’s far better to clear off the debt (and not get into any more if possible!) than cling on to the relatively small amount of interest and security the savings are giving you. Plus, if something unexpected does happen, your strong credit score will mean you can always borrow what you need to cover an emergency.

Option #2 – move to a low-interest loan

Advantages:

  • Improves interest rate

  • Helps build credit rating

  • Lower monthly payments

When you are trying to raise cash at short notice, you will often be willing to take out a loan at a high interest rate – often at 30% or more. Once the immediate need for money has passed, however, and you are into the process of paying back the original loan, you will have the time and space to shop around for better options.

In fact, often the very fact that you have been regularly paying off your high-interest loan will improve your credit score enough that new options may appear that weren’t there at the time.

Taking out a replacement low-interest loan to pay back the higher-interest one doesn’t decrease your debt at all, but it does significantly lower the amount you will pay back in the long term.

You are going to be subject to some fees and charges for repaying your original loan early. Make sure you know what these are by speaking to your lending bank and factor them into your calculations.

Option #3 – renegotiate the length of the loan

Advantages:

  • Loan paid off quicker

  • Less interest paid

  • Can improve credit rating in the long term

If you are paying a loan back over five years but you find you could afford a little more on each monthly payment, then it may be worth seeing if you could reduce it to a three- or two-year loan. By cutting the length of the loan down, you dramatically reduce the amount of interest you will pay overall.

Like option #2, this is usually a case of shopping around for a new loan on shorter payment terms and using it to repay the original loan – if you are lucky, you can combine the two options and end up with a shorter term and a lower interest rate!

Option #4 – look at debt consolidation loans

Advantages:

  • Simplifies finances and budgeting

  • Lowers interest paid

  • Avoids charges

A debt consolidation loan is simply one large loan to bring all your outstanding debt together and pay it off with one easy-to-manage monthly payment at a lower interest rate to other loans. A consolidation loan could be used to pay back an existing loan, clear credit cards and remove overused overdrafts.

It is important that you make sure the interest rate on your debt consolidation loan makes it more appealing than simply continuing as you were paying off the individual debts.

Option #5 – make overpayments

Advantages:

  • Loan cleared sooner

  • Makes use of free cash and avoids frivolous spending

  • Improves credit rating

An extra payment, or overpayment is a way of simply ad-hoc paying off some of the loan, making the remaining balance smaller and thus cutting the interest down.

If your loan was taken out after February 2011, then you can make overpayments at no additional cost, but you must communicate with your bank and give them notice of the intention to make the extra payment and then follow their process for doing so. This notice period means that though you will lower the interest overall, it is not going to come into effect for the next regular payment.

If your loan is older than February 2011 then there may be fees or additional charges to be met when making an additional payment.

Option #6 – use a credit card to pay back the loan

Advantages:

  • Can reduce interest to 0%

  • May improve credit score in the long term

  • Flexible repayments

If you are very good with your money management and know that you can clear the credit card in the required time, then some 0% balance transfer cards will allow you to make a cash payment to clear a bank loan.

Do remember though, that once the interest free period is up, the interest rate on the credit card is sure to be higher than the one you previously had on the loan. Paying off loans with a credit card is viable if you are absolutely sure you can cover the balance before that interest free period is over, but if you are in any doubt, other options are more sensible.

Loan advice with Compare UK Quotes

At Compare UK Quotes, we have a library of articles for you to help with your personal finance. With articles about secured loans, consolidating debt to reduce loan payments and avoid interest, and guides to budgeting we cover a broad range of debt and finance management topics.

So, whether you want to know more about the UK credit rating, or are thinking about broader topics such as life insurance or you’re looking for the best way to finance a new car, we have the in-depth behind-the-scenes research and expert advice for you!


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