One in three people are pointlessly racking up interest rate charges by holding onto personal debt they can afford to pay off with their savings, new research reveals.
Choosing not to pay off credit cards or personal loans is costly because interest rates typically levied on such debts are huge compared with the returns you get from stashing money in savings accounts.
For example, a £2,500 balance on a credit card at 18.9 per cent for a full year would cost you £472.50. But keeping £2,500 in savings paying interest at 1 per cent would earn you just £25 in that time. Using that money to get shot of the debt instead would make you £447.50 better off over a year.
Dutch bank ING, which polled around 14,600 people last October, found those in the US were most likely to do this at 49 per cent, while those in the Netherlands were least likely at 19 per cent.
Economist Ian Bright, who heads the eZonomics behavioural investing team at ING, says there can be good reasons to hold onto debt even when you have the means to pay it off, such as avoiding early repayment penalties.
Also, sometimes people come into money and put it aside to pay off debts once such penalties have lapsed.
Others like to keep a borrowing channel open for credit reference purposes, and to ensure they can use it as a form of liquidity – accessing cash at short notice – in the future.
‘Properly handled it can make a great deal of sense. However it can be tricky. You have to be very disciplined to make this work,’ says Bright.
While Bright doesn’t think it is necessarily ‘wrong’ to co-hold debt and savings, he warns that doing so is costly and can tempt you to run up further debts.
To those who baulk at paying off debt in order to preserve ‘liquidity’, he points out that the times when you are likely to need emergency funds are generally when your income is under threat, and you are least able to pay back debt.
Andrew Hagger, expert at independent advice website Moneycomms, says people tend to look at savings as a safety net – something to fall back on if their car breaks down, for instance – but it is still better to use such funds to pay off debt.
He points out that if you have a credit card that is fully paid off every month, that is effectively your ’emergency fund’, available for use if you do run into financial trouble suddenly.
‘It makes sense to pay off your debts. If you get 1 per cent interest on savings, and typical credit card interest is 18.9 per cent, when you look at these figures it’s almost a no-brainer,’ he says.
‘If you are worried about not having an emergency fund, then if you have got a credit card that’s an option for you.’