How, or should I repay debt during Covid-19 crisis?

Question

During Covid19 pandemic I managed to save some money and I was thinking about repaying some of my debts, however, I'm not sure should I do it, or keep cash just in case things turn for the worse. This is my situation with concerns against repaying each debt.

I have roughly 7000 GBP

I have three debts:

1. 6500 GBP overdraft (APR 35%)
2. 2500 GBP PayPal credit (APR 19.9%)
3. 1600 GBP Amex credit card (APR 23.5%)

I could repay my overdraft, it would save me around 150 GBP each month and I could still use it as if money would be in my bank account in case of a real emergency.

I could repay both PayPal and Amex cards saving around 120 GBP each month and have some money left. My concern is that PayPal Credit and Amex are the least acceptable forms of payment in the UK and in case I would need access to money there is a chance I won't be able to use.

I can just keep the cash and pay interest on all three accounts until crisis is over.

What should i do?

Answer 1

Keeping some liquid cash is sensible, but the exorbitant rates on your debt will hurt you long-term. Pay them off as quickly as safely possible.

Since you have high-interest debt, getting rid of that debt is more important than maintaining a large emergency fund. Having both savings and overdraft fees is illogical. However, I understand that you'd rather have cash than paying of other debts if you expect to be laid off soon.

To save the most money, the optimal solution is to pay off the highest-interest debt first. Here, that is the overdraft.

Unless you will also be able to pay off the other debts within a couple of months, it could be sensible to refinance. A small loan for £5000 at 6% over 12 months (~ £440/month) could give you breathing room to pay off all high-interest debts and stabilize your finances – if you are still eligible for such loans.

Aside from affecting job stability, the Covid-19 situation doesn't change a lot. If you've struggled to live without debt pre-Corona, it won't get easier now. That's why it could be helpful to pay off as much as possible now, so that you aren't saddled with endless interest payments in more difficult times: who knows how long this crisis will last? And you need to figure out why you have so much cash and so much debt, but that is out of scope here.

Answer 2

If you are sure they'll let you overdraft your account again, then for Heaven's sake get rid of that ridiculously high APR of 35%. Keep the rest as an emergency fund. 500 GBP is not much, but more than nothing.

Then gradually get rid of the other debts, if only with the 150 GBP/month you just saved. This makes you get rid of the Amex debt in 10 months and the PayPal credit in about 20 more months.

Or even better, get rid of them immediately by refinancing with a lower APR. But this can be only be a temporary solution, the long term solution can only be to pay them off.

Answer 3

I have three debts:

6500 GBP overdraft (APR 35%)

2500 GBP PayPal credit (APR 19.9%)

1600 GBP Amex credit card (APR 23.5%)

I have more debts than you (four of them, not three).

My smallest debt is way larger than your largest debt.

Guess what? None of my debts has more than 3% interest rate.

Get rid of these debts! As soon as possible, I might add. I don't know what you were thinking when getting a debt with >5% interest rate (¹). Don't ever do such a thing again!

Getting rid of these is made easier by they being relatively small. My total debt is about 10 times larger than your total debt. The secret to managing debt is: only take debt when you are getting it with a low interest rate and manageable payback period.

Your debt has so ridiculously high interest rate that getting rid of it should be your first priority. You can use the credit card as your emergency fund, so your first priority really should be getting rid of these debts, not setting up an emergency fund.

Then, set up an emergency fund of few months expenses at least.

Then, you can start investing. Stock market yields 8-10% per year. Much less than any of your debts. But I would say, given even a 10% yield will eventually make you rich if you consistently save and invest.

A 20-35% debt, on the other hand, will nearly immediately make you poor unless you can get rid of it very quickly.

(1): Ok, in times of high inflation, even >5% interest rate debt might make sense. But in times of low inflation, it does not.

Answer 4

This debt didn't make itself. I am concerned that if you pay down this debt, you'll simply borrow again soon enough, and you'll be right back on the debt treadmill.

Suze Orman used to preach "3-6 month emergency fund" like everyone else. And then in 2008 when the market tanked, all she's said since was "8 month emergency fund".

When you've fallen back onto it, you cut unnecessary expenses, so it pays for rent, food, debt minimum payments etc. Your country's social services may help you.

It sounds like you borrow a lot and having cash-on-hand is fairly unusual, and you haven't thought much about an emergency fund because that seems implausible for you.

I might guess you feel somewhat uncomfortable "just having" this money. We have an expression "burning a hole in your pocket". It's common to have a feeling like you need to spend it on something smart... before you spend it on something stupid. Or, as often "happens", some sort of "emergency" comes up that feels like it can only be cured with money. (the rest of the time, the "emergencies" still happen, but one is inspired to find a cheap way to solve it.)

All that to say, that sense of "use it or lose it" is real and reasonable. But it is due to erroneous thinking about money. If you can think about that nest-egg having a job to do, and can refrain from feeling like it's "burning a hole in your pocket", and can hold yourself back from stupid spending, and solve your "emergencies" in a moneyless way even when you have it... Then I think you have the core of a proper emergency fund.

And when you save for that purpose, it becomes easier to save for other purposes. That opens the path to investing. And now you're using money effectively instead of it using you.

Answer 5

There is no point whatsoever in hanging on to cash as an "emergency fund". The fact that you have access to a large overdraft and a couple of credit cards gives you a source of funds in an emergency, and gives you even more if you get those paid off. So it always makes more sense to pay off debt than to hold on to money.

Here's what I think you should do.

(1) Pay off that £6500 in its entirety. As soon as you possibly can. Stop using that giant overdraft, but keep it available in case there's a real emergency.

(2) Pay the remaining £500 into the Amex card.

(3) Use your Paypal card to pay off the balance of your Amex card, assuming that £3600 is within your credit limit.

(4) Open a new credit card. Whichever type is the most widely accepted credit card in UK. I'm not in UK so I don't know what this is, but maybe Visa or Mastercard. This will be for your day to day spending. Whenever you want to purchase anything from a merchant who accepts a credit card, and doesn't charge a surcharge for doing so, this is what you'll use. You must make sure that you pay this new credit card off in full by the due date every month, and never use it for a cash advance. That way, you can avoid paying any interest on it whatsoever. And because you get between 3 and 7 weeks of free credit whenever you use this card, this will make it easier to pay off your other debts.

(5) Every time you receive income, figure out how much of it you'll need to retain for expenses on which you can't use a credit card. This might include rent, power, internet, insurance, and a bunch of other things. Pay the difference into your Paypal card. This will enable you to clear the debt on your Paypal card as quickly as possible.

(6) Every time your new credit card falls due, pay off the entire amount, using the Paypal card. If this would make the Paypal card exceed its credit limit, then use the Amex card instead. Never miss the due date on your new card, or pay less than 100% of the balance, otherwise you lose the "interest free" advantage.

(7) Every time you need cash, and you haven't retained enough from your income, use your Paypal card. If this would make the Paypal card exceed its credit limit, then use the Amex card instead. But never use your new credit card for cash advances.

This will be the fastest way to pay off your debts. Once all three credit cards are clear, think again about how much of an emergency fund you really need. Keep whatever credit card(s) you need for this. Destroy the others and close the accounts. Also close the overdraft.

Answer 6

Liquid cash is also freedom. You could get a sowing machine, order some fabric, and make masks for people to wear for CoViD19 -- If you sell them for a profit (not too much, though) it would be a win-win for both you and those you serve: You help them not to get sick, they help you to get out of debt, and you make yourself part of the solution. A genius country doctor used to ask me every time I went to do him, "so... what are you doing for the good of the world?" I never forgot it. What looks like a problem may actually be an opportunity. Best of luck to you.