SHOULD I PAY OFF MY CREDIT CARD FIRST?
Credit cards typically charge the highest rates so paying them off will give you your highest effective interest rate, but don’t pay off so much that you may need to borrow it back next month.
Most credit cards charge a flat fee of around 2% for cash withdrawals plus interest of over 1% per month (12% p.a.). If you borrowed for a single month, it would cost over 3% – equivalent to 36% p.a.!
Currently interest rates are at record lows, which is great if you’re paying off debt but how can you get a decent return if you’re not?
If you have a home loan or other debt…
Every business must earn a margin to survive, so the highest interest you can earn is the rate that financial institutions charge you. How? By minimizing the interest you pay. The good news is, many institutions offer products that make it easy for you, and even the taxman is happy to help!
Here’s a simple example:
Lets say you have a $100,000 mortgage (on which you pay 5% p.a.) and $5,000 in your savings account (receiving say 3.5% p.a.). In one month you will pay $416.67 of mortgage interest and receive $14.58 of savings interest. After tax (of say 30%) your savings interest for the month is $10.21.
But, if you use the $5,000 to reduce your home loan to $95,000, monthly mortgage interest will drop to $395.83, a difference of $20.83 (and you don’t pay tax on the amount, because it is not income).
In this example you double your effective interest rate. ‘But what if I suddenly need the money’ you ask. Good question – read on.
Effectively earn high interest by minimising the interest you pay …
- Pay off your credit card and any personal loans if you’re sure you won’t need the money (see right).
- If you have or need a home loan, investigate mortgage offset accounts and think about having your salary paid directly into it, so you effectively earn high interest from the day you get paid. For more information, see ‘The pros and cons of a mortgage offset account’
- If you have a home loan without a mortgage offset account, talk to your lender and if that doesn’t work, consider refinancing.
If you’re debt free …
- Does your bank offer online savings accounts? Many institutions offer them free of account or transaction fees when you link them to your transaction account. That means you can transfer most of your salary into them as soon as you get paid, then put money into your transaction account as needed. With a smart phone and a banking app, you can usually even do this while you’re shopping.
- Shop around for a high interest account. Use a comparison website to see what rates are being offered:
Make sure you check the details directly on the providers’ websites, particularly any fees and restrictions.
Many of the comparison sites also show term deposit rates, but beware of early exit costs and automatic renewal clauses.
What about long term savings?
- Interest on a bank account might pay 2% to 4%, before tax. Bank shares yield 4% to 5% or more – and most pay fully franked dividends so you pay little if any tax, plus they offer the potential for capital gain.There is also, of course, risk of capital loss – particularly in the short term. If your investment horizon is ten years plus, though, downside risk is historically very low. In this case you may wish to consult a financial adviser about your investment options.
What are your thoughts?
Do you think this information will help you to secure a better rate of interest? Did we leave anything out? Is there anything else you’d like to know about managing your savings?
Join the conversation — leave a comment below and let us know what you’re thoughts are.
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