I’ve got the money to pay off all my overdraft, I contacted my bank and arranged a plan to pay it off for £45 a month, £25 on interest, £20 paying off the actual debt of £1000 over 18 months, but that got me thinking, wouldn’t it be better just to pay it off all at once? I mean, I’ll only reduce the debt to around £700 pounds after all that time. What’s the best course of action?
Assuming no penalty for early payment.
Say you now have £1000 in your piggy bank. Your funds are equal to your debt. If you give it to the bank you have nothing and are out of debt.
If you pay the bank £45 out of your £1000 next month, you will have £955 and owe £980. You are now in the red and cannot choose to pay off your debt. And every succeeding month puts you further behind - you lose £45 from the piggy bank but reduce the debt by less than half that.
By the way are you sure you don’t owe this money too a loan shark? That is a pretty extortionate interest rate.
IMO, if you can afford to give them 45 a month and still have money to live on AND you have a thousand pounds, I’d just pay it off now. Then you’d have the 45 a month you were going to give them to yourself on top of your other money and you’d be saving the 300 pounds a year in interest. (I feel so British, I’ve never spoken in Pounds before).
Just make sure you can afford to give away the 1000 pounds. Sometimes it’s better to be in debt, then to have no savings, you don’t want to give up the 1000 pounds and then suddenly need the cash for an emergency.
Also, like don’t ask said, make sure you’re just paying off principal at this point. If the bank has you on a payment plan, they may have pre-loaded the interest. I don’t think that’s legal anymore in the states, but I don’t know about over there. It doesn’t sound like that’s the case though.
I’ve had this loan for nearly 10 years, it was a student overdraft originally, why would you get a penalty for early payment? I originally just paid £25 to cover the interest and a little bit went to the actual debt, but I received a letter from them saying they were considering lowering my overdraft limit, even though I don’t actually use it.
This is with Natwest, the customer adviser said that over time the interest rate would come down in line with the overdraft being reduced.
Many loans charge a fee if you pay them off too soon. They give you the money with the assumption they’ll get at least a certain amount of interest back. So if you take a out a 5 year loan and decide to pay it back in 1 year, they might not be thrilled when they only make $300 in interest instead of $800 (or whatever the numbers are). And since small loans like those don’t have closing costs, they hardly make anything since that little bit of interest might not even cover the actual (overhead) costs of the loan.
Also, I assume you’re talking about a ‘loan’, in the States an overdraft is when you take your checking account below zero.
It’s just an extension of credit on an existing current account with interest added.
I would call the bank and say ‘How much to clear this debt today?’ If you have it and a little extra to get you through the month - pay it off.
I take it “overdraft” has a different meaning in England than in the USA? Some sort of pre-negotiated arrangement?
ETA: nevermind, either didn’t notice or was sniped by Joey’s comment.
If you’re paying 25 in interest on a debt of 1000 each month that’s an annual rate of over 30%. Which is terrible. Pay it off as soon as you can.
Brit with Nat West bank account checking in. To clarify a few questions that have been raised - “overdraft” in Britain has the same meaning as what you are all saying, it’s where your bank account has a negative balance. However, there is a distinction between an “arranged overdraft”, where the bank has agreed in advance it will let you have a negative balance, and an “unarranged overdraft”, where you accidentally go into the red (or exceed your previously arranged overdraft limit).
In the UK, for many years it has been very common for banks to offer accounts to university students with an interest-fee overdraft facility. The reasoning behind this is that students need money now, but are more likely to be well-paid in the future than non-graduates (or so the theory goes, let’s not have that debate here). So by giving it to them interest-free, the bank takes the hit initially but hopes to gain a loyal customer who will be maintaining a reasonable credit balance once they get a graduate job.
Now, most banks will start charging interest on any remaining overdraft around a year or two after graduation. It seems the OP is in a situation where that is the case, I can confirm an APR of near-30% is pretty typical for this sort of arrangement. As such, I concur with the advice already given in the thread, which is to pay it off as soon as possible. I’d be amazed if there were any fees from the bank for this, basically they want their money back (it’s not like a loan). On the other hand, they are making lots more off you if you continue with this payment plan.
Just one caveat - as has been said, if your credit rating is really poor and you may need that £1,000 of savings in the next 12 months (for something essential like an unexpected vehicle/house repair), and you will be unable to borrow money to cover it except from some payday lender at an even bigger interest rate, that could be an argument for keeping your savings, as otherwise it could lead to more trouble later on.
Pay it off ASAP. That interest rate is obscene.
I didn’t know it was 30% that’s crazy
Loansharks would be envious of that ROI.
Yeah, you might even be better off paying with a credit card at that rate.
What’s the contract say? Seriously, go grab the paperwork and look. If you don’t have it, ask for a copy from the bank. Because the way you write this, it seems as if you and the bank have come to an agreement of a £45 25/20 split. And if I were the bank, I’d be thrilled to accept that sort of arrangement. That’s £300 a year on a 1000 note. And yes, that’s 30%.
Actually. Scratch that. It’s MORE than 30%. Because when you’ve worked out a constant amount for interest but the principal keeps going down, each month the interest actually increases. For instance, when you have just 20€ left and your agreement is to still pay 25/20, that last month you’re paying off your loan in full while paying 1440% in interest!
Sound crazy? It is. Stop that madness now.
Look at your paperwork and find another deal.
There is an account charge of £6.00 and the interest is £15.60 monthly, that was before I made the 25/20 arrangement.
Can someone explain to me in extreme layman terms what compound interest is all about?
Compound interest, in its simplest terms, is interest accruing interest. When you’re investing, it’s good. When you owe money, it’s bad.
Here’s an example. Let’s say you have a debt of 1000 with 12% interest compounded monthly. What happens is they take the 12%, divide by 12 (the number of months in a year), and you have a 1% monthly rate.
So let’s say you pay nothing on it for a year.
By February you owe 1,010 (Or 1,000 * 1.01).
By March you owe $1,020.1 (Or 1,010 * 1.01). You’ll note that the amount of interest you owe from the previous month went up by .1. That’s because you owe interest on the interest.
April: 1030.3
May: 1040.60
June: 1051.01
July: 1061.52
August: 1072.14
September: 1082.86
October: 1093.69
November: 1104.62
December: 1115.67
January: 1126.83
So if you had just a straight debt of 1000 with 12% interest, you’d expect to pay $120 interest for the year. But compounded (monthly) interest means you owe an extra $6.83 on top of it all.
And if you compounded your debt with daily interest (which sometimes happens)? You’d owe an extra $7.45 over the regular uncompounded debt.
These things add up. The more you know, the more you understand about the agreements you enter into, the better you can be in control of your finances.
Let’s hope you got a refund for your tuition. 
30% APR is high, but the point I was making in the final paragraph of my previous post is that if you’re really desperate for cash and have a poor credit rating, your only option may be to approach a so-called “payday lender”, whose interest rates are commonly in the 1,000+% APR range.
Nice work by the bank although I’m not sure why they want you to pay it off. If you’ve had the debt for 10 years and the account fees and interest have remained roughly the same they have already earned two and a half grand without you paying off any debt, just the vig. They could keep that up forever.