I have €20,000 in a current account but want to use it in a better way. My wife and I have ten years left on a 15-year credit union home loan of €120,000 at 6.5 per cent APR for a total repayment of €186,000. There is no penalty for early repayment of part or all of it.
I also see that the State Savings 10-year National Solidarity Bond is offers a total return of 22%. Which option is better?
Like many of us, you’ve realised that sitting on cash in your bank, especially in inflationary times, is not a winning financial strategy. Bank deposit rates remain laughable in Ireland – the European Central Bank’s base rate is 16 times AIB’s personal demand deposit rate, and 40 times Bank of Ireland’s standard demand deposit rate.
Frankly, the banks don’t really want your cash. Almost anything you do to put it to work will improve your wealth compared to leaving it on deposit in an Irish bank.
The case for paying down debt
While low-risk investments growing in line with the ECB rate of 4% are available, in your case, paying off a chunk of debt is likely the best option. Doing so will avoid a substantial amount of future interest cost – which is a major saving for you. You could use that saving either to get rid of the loan early, or to reduce your monthly payment.
Let’s look at how powerful this saving could be. I estimate you’re currently paying €1,033 per month. Reducing your loan balance by €20,000, and keeping your current loan payment, would mean your loan will be paid off 34 months earlier than planned. That’s almost three years.
Alternatively, you could keep the loan with its current ten years to go, and your monthly payment would reduce by €225.
Choosing the first route will make you more money. You will be paying the loan back faster, so you will incur less interest.
What about State Savings?
In case I’ve not convinced you yet, let’s scrutinise the alternative of State Savings. The total return of 22% is equivalent to 2.01% per year. Paying interest on a loan at 6.5%, while receiving interest on savings at a fraction of that, makes no sense.
What’s more, if you need the money during those ten years, you’ll receive far less, because returns from State Savings are heavily back-ended. If you were forced to cash in your State Savings in year 3, for example, you’d receive just €20,400 back in total, or 2% growth.
In contrast, it’s likely the credit union will look on your situation favourably if you need to increase your loan some time after an overpayment.
Before you decide…
There are some situations where it might make sense not to pay down your loan with all of your savings.
For example, if you have other, higher-cost loans, such as car finance which you can pay without penalty, or credit card debt, these are worth prioritising.
Secondly, it’s worth keeping some savings in readily accessible cash for emergency purposes – 3-6 months’ post-tax pay is one rule of thumb.
And lastly, paying into a pension, where tax relief makes the savings greater, could make a lot of sense depending on your retirement provision.
This is adapted from a Moneycube column which recently appeared in the Sunday Times.