Paying down debt: overdrafts, consolidation and the true cost of credit

A lower monthly repayment over a longer term usually costs more in total. How to compare loans, use overdrafts sensibly, and decide whether to consolidate.

Debt is cheapest when it is short, small and on the right product. Three ideas from consumer guidance in Ireland cover most decisions. Compare the total cost, match the loan to the need, and get help early if repayments slip.

The cost of credit (APR)

Lenders must quote the Annual Percentage Rate (APR), which includes fees as well as interest. APR lets you compare loans of the same amount and length. For loans of different lengths, compare the cost of credit: the total you repay less the amount you borrowed.

The five-year loan has a lower rate, but costs more in total than the three-year loan, because you pay interest for longer. Stretching to seven years cuts the monthly payment again and raises the cost further. The rates here are examples; the Competition and Consumer Protection Commission publishes comparisons of current loan rates.

Overdrafts

An overdraft lets you spend below zero up to an agreed limit. You pay interest only on what you use, but the rate is usually higher than on a personal loan. There may also be a set-up and yearly fee. It suits short gaps and small amounts. If you are permanently overdrawn, a personal loan repaid over a fixed term is usually cheaper and gets you out of it.

Credit cards

There is no interest if you clear the full balance by the due date. Otherwise rates are high, so a card is not a way to borrow for long. If you carry balances on several cards, pay the minimum on each and put everything else towards the one with the highest rate.

Consolidation

A consolidation loan replaces several debts with one. It can help if the new rate is lower and the term no longer than the debts it replaces. It backfires when the lower monthly payment comes from a much longer term, or when the cleared cards are used again. Adding debts to a mortgage turns unsecured debt into debt secured on your home, usually repaid over many more years.

Before consolidating, work out the total you would repay under both options, not only the monthly figure.

If you are struggling

• Talk to the lender early: arrears are recorded on your credit report, so agreeing a plan before you miss payments matters.
• The Money Advice and Budgeting Service (MABS) can help you work out what you can afford and contact lenders for you, free of charge.
• Borrow only from lenders authorised by the Central Bank.

Work it out

• Plan to clear your debts →
• Should I combine my debts into one loan? →
• Your monthly budget →

Sources

General information, not tax advice. HeyPenny is not a tax agent.