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This is my current loan.

  • Loan Amount : £11,750
  • Total Interest : £6,422.40
  • Interest Rate : 21.2% per year
  • Total : £18,172.40
  • Pay per month : £306.19
  • Term : 60 months (5 years)

I'm 2 years into the loan, I've made 24 payments of £306.19. I'm not facing redundancy(touch wood) or any other issues, but I really want to clean up on this loan as fast as possible so I can move on in life and look at other things such as a mortgage deposit or going to work abroad.

I called up the bank (Barclays if that makes any difference) and enquired about my loan (since I've had no correspondence from them in 18 months and don't know where I currently stand)

  • Paid so far : £7348.56
  • If I carry on as normal, current balance is : £11,117.84
  • If I pay up early, as in next month, the total payable will be £8,789.90

Thats actually quite shocking, so I've pretty much spent 2 years just paying interest, and have only just got below the original amount borrowed, this has led me to think "right, what can I do about this?"

I've looked around, on MoneySupermarket.co.uk at personal loans, I've found a personal loan for the £8,789.90 from Nationwide, at 7.6% APR, Monthly payments would drop down to £271 and total repayable works out at £9,787

I don't have any savings, so its not like I can just clear it out now, but I'm thinking maybe I should take another loan, as the total repayable on a new one is considerably less than my current one.

I would take the new one for 3 years as that's what I have left on my existing one. My general idea is to get rid of it as quickly as possible so I don't want to start another 5 year loan.

What would you do? I'm a youngster and this is my first adventures in loans so I'm pretty hopeless at the moment!

Thanks!

  • Hi James. Just a small question I'm curious about before I answer: Were you paying 21.2% interest originally because you didn't have a great credit rating? Do you think your chances of getting the 7.6% loan are pretty good now that it's 2 years later? – Chris W. Rea Feb 24 '10 at 0:31
  • @Chris, there are a number of reasons. 1) it was my first loan ever. 2) it was car finance, generally high rates anyway. 3) I had no credit cards at the time so had no credit history. 4) was 21, straight out of uni, so that didn't help. I've always made payments, no issues etc so I imagine my credit rating is pretty good now ;) – James Feb 24 '10 at 18:30
  • 21% interest is PAINFUL! That's like "I defaulted on alll my credit cards" sort of interest. My first auto loan (in the US) was at 8.6%, and I know interest rates can vary internationally, but that's.... way out of line with what I'd expect for the UK. I'd also recommend if you refinance, try to pay more than the minimum payment (keep it up around $300/mo) and knock it out even earlier. – fennec Feb 26 '10 at 1:23
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    @fennec: I've seen 19.99% interest rates in the US for a new car to someone 20 with no credit history at all. It happens here in the US too. – Alex B Sep 17 '10 at 15:37
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OK, first things first: Don't be shocked! Here's why. When you say:

If I carry on as normal, current balance is : £11,117.84

... then you're actually considering interest that hasn't been charged yet. That's not really the "current balance", but rather the sum of all future expected payments. That is, it's the amount if you were to carry on and do nothing to change your loan circumstances.

The more important figure is this:

If I pay up early, as in next month, the total payable will be £8,789.90

That number is roughly in-line with what I calculated as owing after two years of payments on such a loan. But, your figure is actually slightly higher; but I'm not sure of the exact compounding rules or if a pre-payment penalty that might be built into that number (e.g. 3 months' interest penalty to get out?), but my number is within about one payment of your amount.

Anyway, you have actually made some progress on your loan: You borrowed £11,750 originally and you've knocked £2960 off the principal of the loan. You're only facing another £11,117.84 in total payments if you stay the course on your initial loan.

Next, the question is: Should you take the new loan to pay off the old? I suggest yes. Considering you were a new borrower two years ago, you were a higher risk, and that's why you paid 21.2%. Now you have some good history behind you. Use it to your advantage.

If you can qualify for the 7.6% loan to pay off the original loan, it's almost a no-brainer. By switching, your total payments go to:

(24 * £306.19) + (36 * £271.00) = £17104.56

Compare that to the original £18,172.40 you were expected to pay on the high interest loan over 60 months and you're ahead of the game by £1067.84. That's certainly enough of an advantage to switch.

But, as MrChrister suggested, do find out about all fees, penalties, etc. before you proceed. I suspect the penalty is built into the £8,789.90 amount you mentioned, but make sure you know exactly.

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What are the closing costs and total fees for the second loan? At £30/month savings, how many months until you "save" the same amount as the closing fees? (If any)

You will get a much better rate, but you will be adding 2 years to your total payback period for the sum or money you originally borrowed. Do you want to be on the hook for an extra two years? Probably not if "moving on" is a goal.

As an alternative to another loan, how about you accelerate your current one?

Take your monthly payment of £306.19 and divide by 12, which is £25.52. Start making payments of £306.19 + £25.52 and make sure your bank understands the extra is to be applied to the principal, not the interest. You can knock a few months off of your loan that way. You can pay more if you want to get done sooner than later.

BUT...

As you have discovered, most loans are "front loaded", which means you pay all your interest up front, and the interest is the profit for the bank. The principal is what gets addressed at the end of the loan, and you are almost halfway through so your principal is going to start dropping dramatically. Accelerating your principal payments is fine, but it might not save you much money in the overall.

I also don't think getting a new loan will ultimately save you money overall either. You will just be paying more interest to a new back on the same principal.

Somebody good with a spreadsheet can make up a amortization table and compare than to find out the totall dollars spend from this day forward.

  • I think this is one of those cases where it's better to run the numbers before answering ;-) – Chris W. Rea Feb 25 '10 at 0:59
  • But I don't really know how to run those numbers... =( – MrChrister Feb 25 '10 at 5:26
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    I'm seeing this on a lot of answers: it's "principal" not "principle". – DJClayworth Jan 7 '11 at 22:16

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