With savings rates falling off a cliff, your money will be far better utilised paying off existing debt rather than squirreling it away.
Top saving rates have fallen from their summer highs of 7.3% to below 5%, and with the Bank of England cutting the base rate to its lowest ever level last week, they will almost certainly drop further in the near future.
Amazingly, some “savings” accounts have already fallen to 0%, while around four in ten now pay a paltry 1% or less.
But while savings plummet, the rates on many forms of credit have actually increased in recent months.
Credit cards, loans on the rise
According to debt charity Credit Action, the average APR on credit cards increased from 17.45% in September to 17.9% by Christmas.
Similarly, many banks have actually been hiking the rates on personal loans despite the falling base rate, with even the most competitive deals now charging between 8-9% interest.
As a result of this growing chasm between savings and debt, the argument for using any spare cash to reduce arrears rather than saving for a rainy day is stronger than ever.
A practical illustration
Consider the following example. Lets assume you owe £2,000 on your credit card with a typical 17.9% APR. Should you simply allow this debt to accumulate, you will have racked up roughly £360 interest in one year.
Now let’s assume you have £1,000 in additional savings, which you decide to use to reduce your arrears.
Do this and your remaining credit card balance (£1,000) will rack up roughly £180 in interest over the coming year. In other words, your repayment has saved you £180.
However, had you instead put your £1,000 in the top paying one year fixed rate deal – currently 4.65% AER at ICICI – you would have earned yourself just £38 after tax.
Never use all your savings
Of course you should never use all your savings to reduce debt - life can often throw up surprises that require you to access money in a hurry.
As a general rule, an emergency savings pot should contain at least three months salary.
So where should you keep these savings? Well, as we mentioned earlier, the best paying rate offer is currently 4.65%, available on ICICI’s one year HiSave Fixed Rate Account.
