Credit or debit interest?

A common mistake made by people considering switching their current account is to get the best interest rate on credit balances.

This is something that is actively encouraged by some banks and building societies – many of which are now competing to offer the best interest rate on balances in credit.

However, unless you normally end the month in credit, your priority should actually be to reduce the bank interest rate you are charged on debit balances. After all, if your salary is £1500 a month and you regularly run up an overdraft of £1000, you are unlikely to be in credit for very long in any given month and will pay out a lot more interest than you earn.

It is always worth comparing the bank interest rates applied to different current accounts, particularly if you are prone to accidentally slipping over your overdraft limit at the end of the month.

See our other current account best buy recommendations

Offset your savings against your debts
The latest twist on current bank accounts is called offsetting. There are now current bank accounts available that allow you to combine your income and your savings and set them against your debts.

Instead of receiving interest on your savings, you reduce the amount of debt on which you pay interest. So, if you had £8,000 of credit card and overdraft debt, say, but £6,000 of savings then, instead of receiving interest on £6,000 and paying out interest on £8,000, you just pay interest on £2,000.

Offsetting brings a tax benefit, as the interest you receive on your savings is taxable as income; whereas reducing the interest you are charged on your debts does not attract tax. This tax saving can mean that you are effectively getting a high interest rate on your savings.

Of course, your savings will not actually grow with this system, but your debts could shrink faster. It is possible to combine your current bank account with your mortgage, credit cards, savings and overdraft. You could save thousands over the life of a mortgage loan with offsetting; however it could also cost you if you are unable to resist the temptation to run up more debt.

Another downside of offset current bank accounts is that all your financial affairs are then in the hands of one lender. This means that they will be able to see virtually your entire financial situation at a glance. If you are comfortable with that situation then offsetting might be worth considering – if not then it may be a step too far for you.

See our other current account best buy recommendations