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Understanding your debt

If you’re trying to deal with debt, the amount you owe isn’t the only important factor to take into account. You also need to get a clear picture of how expensive your various types of borrowing are.

Pay off the most expensive debt first

For anyone who finds themselves in the red, whether via a credit card, overdraft or student loan, the key to financial success lies in paying off the most expensive debt first. For example, if you’ve borrowed on a credit card or a retailer’s store card, you could be facing annual interest charges of 20% or even more.

Overdrafts can be similarly expensive – especially once you factor in the extra charges that most banks now apply to customers who exceed their limits. A student loan, on the other hand, is likely to be among the cheapest methods of borrowing.

If you have enough spare cash, it could well be worth trying to pay down expensive debt rather than putting it into a savings account or other form of long-term investment: your financial situation will be improved if you choose to wipe out a debt running at 20% interest rather than use the same money to save at, say, 2.5% a year.

Debt consolidation

Almost a third of borrowers at Zopa use their loan for debt consolidation. This means looking for a new, cheaper form of credit that can clear any borrowing at high rates of interest and get your monthly repayments down to a more manageable level.

Consolidating existing debts into one loan repayment is perhaps the most straightforward way of consolidating debts. The money you get from the loan can be used to clear any card or overdraft balances, and you have a fixed sum to repay every month. Most importantly, interest rates on personal loans tend to be significantly lower than the standard APRs (annual percentage rates) on cards or current account borrowing. At the moment, for example, Zopa charges as little as 3.9% Rep APR annual interest on a loan of £10,000 over two or three years, and 4.8% Rep APR over four or five years.

Here is a Representative example – A loan of £7,500 over 5 years will cost you £150.74 per month at a representative 7.9% APR. The total cost after 5 years is £9,044, which includes £1,404 interest at 7.1% fixed and a £140 fee. The total amount of credit is £7,640. The rate and fee you are offered will depend on your individual circumstances.

The Zopa debt calculator

Our own consolidation calculator works by typing in what your current debts are, what rate of interest you are paying and how much you are reducing your debt by every month. It will then show how you could pay less interest by consolidating your existing debts through a Zopa personal loan.

For example, imagine you have £10,000 of credit-card debt at 17.9% APR and you are paying off £200 a month. The calculator shows it would take more than seven years to clear this debt, and that total interest costs would be more than £7,000.

With a five-year Zopa loan at 4.8% Rep APR annual interest, however, the debt would be cleared more than two years sooner at a monthly cost of less than £190. And remember: the higher the level of interest you’re currently paying and the more you have borrowed, the greater the potential gains from consolidating your debts.