Good, bad and ugly debt - and how you can tell the difference
Financial literacy among adults is very poor, and we should take no solace from the fact that Ireland is no better or worse than other countries.
A study from Cambridge University recently found a quarter of adults struggle to calculate the change they would get in a shop from purchasing four items, and half cannot read a simple financial graph - the kind used to convey important information about money.
It found "striking weaknesses" in 100,000 people surveyed in 31 countries, including Ireland, about things like interest rates and everyday financial tasks like working out the price per litre or kilo for goods. It's no wonder banks take advantage of customers.
One big bugbear is loans. Do you know how to compare rates, what APR means and how to calculate the cost of credit? If not, then you could end up being charged far more than you need to be.
This week I'm looking at personal loans - popular this time of year as summer holidays and back to school/college costs loom.
Where's the best place to get one, what does it cost and how can you compare? Here are some basic things to look out for first, while the panel shows you some typical current costs:
This is the profit the lender makes on giving you money. For most personal loans the rate is "fixed". That means it doesn't change over the term and your repayments stay the same no matter what. Although interest rates have been dropping considerably on mortgages, they remain high for short-term lending. Banks are borrowing this money themselves almost for free, but charging customers anywhere from 6-15pc to borrow it from them, so it really is worth shopping around to find out the best deal.
Cost of Credit
This is the amount the loan will cost you in euro over and above what your borrow: the "interest" expressed as a monetary figure rather than the annual percentage rate, which can be confusing. Banks must show you this, and it's a great comparison tool. So, for example, if you borrow €3,000 over three years at 9pc, the "cost of credit" to you is €416.74. That is what you repay, on top of the €3,000. Always look for this as it's "real" money.
Borrow More for Less
It surprises many people to learn that banks love to lend. Loans are treated as assets; it's the deposits which are liabilities. So, the more you borrow, the cheaper it is. This isn't to encourage you to get into debt, but if you are borrowing for say, a car, than "consolidating" your other debts, say from a credit card, at the same time can make sense. It's crazy to pay 20pc to Visa when you can pay 10pc to the bank.
For example, borrowing €5,000 over three years costs from 8.5pc (Bank of Ireland) to 14.3pc (Permanent TSB), but taking out a €15,000 loan will cost just 6.3pc (KBC) to 11.5pc (Chill). Of course, your repayments will be higher, but the cost of credit is less.
Secure Against Savings
Most banks and all credit unions will give you a lower interest rate if you have savings backing up your loan. You don't need to use them, just keep them lodged and it's perfectly fine to have both savings and debt at any one time - many people don't want to use up savings to pay down loans if they believe they'll need them for a "rainy day". But if you have very high debts and lots on deposit earning nothing, it makes sense to use one to pay down the other. You do not need to have saved with a bank or credit union to get a loan.
Good Debt v Bad Debt
Not all loans are bad. Good debts are those used to purchase assets, like a house, or perhaps a car. Bad debt, however, is when you borrow for day-to-day spending because you run out of money. A warning sign is when you find you need to use your credit card to pay for weekly groceries, for instance. That's not good borrowing - it's just bad budgeting.
Moneylenders charge extortionate interest rates masked as "low weekly payments" and the "pay day" lenders - or really short-term loans - are the worst. For example, a €460 loan over a year costs €15 per week. But with an interest rate of 157.3pc APR, the total pay back is €780. They prey on those worried they can't get a loan elsewhere, but who may simply not have looked. Also listed as "moneylenders" with the Central Bank are catalogue companies like Littlewoods and Oxendales whose interest rates verge on 40-50pc.