Taking out a bigger loan can actually save you hundreds. Likewise, putting off repaying some debt for years is a savvy move. Confused? Here are three occasions where personal finance flies in the face of conventional wisdom.
The world of finance can be a confusing place, especially when the laws of logic don’t apply.
Here are three occasions where you need to abandon common sense if you want to get the best deal.
1. Borrow more to save money
In most cases when you borrow money you are charged interest, so the more you borrow the more it costs.
As a result, the general rule is borrow as little as possible to keep the cost of borrowing down.
For example, borrow £1,000 at 7% APR and after a year you’ll owe £1,070. But, if you’d borrowed £1,500 you’d owe £105 in interest.
So, if you don’t need that extra £500 don’t borrow it.
But, this isn’t always the case. Sometimes it can be more cost-effective to borrow more.
At present, in the personal loan market there are some instances where borrowing just £100 more could result in an enormous drop in the interest rate you are charged, significantly reducing the overall cost of your loan.
For example, the cheapest rate we could find on a £4,900, four-year loan was from AA Loans has an interest rate of 8.3% APR over four years, costing you £831 in interest.
However, if you borrowed £100 more, the cheapest £5,000 loan rate plummets to 3.8% APR from Cahoot, halving the cost of the loan and bringing the total interest paid down to £390.
In this example, borrowing an extra £100 would save you a whopping £441 in interest!
The reason why the rates can be so drastically different is fairly straightforward. Banks will obviously charge higher rates on smaller loans and lower rates on bigger sums. Most will have set thresholds where a loan jumps from small to medium, to large by their calculations.
If you come in just under one of these thresholds you'll generally be better off borrowing a bit more to get a better rate. It's not set in stone, but £5,000 and £7,500 are commonly used as the points at which rates change.
If you are looking for a personal loan make sure you check the interest rates for borrowing slightly more than you need, you may find you save yourself a fortune by borrowing more.
2. Don't pay off debt too quickly
In general, most of us think debt is best avoided because it will cost us money. But, there are some scenarios where you can actually make a little money from borrowing.
You're all too aware of the impact inflation can have on savings, but of course it also does the same to debt: it gradually erodes its value.
So, if you are offered a lengthy 0% period on a purchase, such as those commonly seen on sofas or kitchens, it could be worth buying it on credit.
If the alternative is saving up for it then you’ve locked the item in at a lower price as inflation will generally increase it by the time you could afford the upfront cost.
Just make sure you can afford the repayments.
Even if you can afford to pay upfront, you should still take the interest-free credit.
Then, put the money into a savings account and repay only the minimum payments over the term. That way you hold onto your cash and earn interest on it rather than handing it over upfront.
3. Rack up debt to prove you're good with money
Most people assume that if you’ve never borrowed any money you’ll have a perfect credit rating.
But, that isn’t actually the case. Apply for credit for the first time and you may find yourself rejected for the best deals or offered a higher interest rate.
How to improve your credit rating
The reason is lenders like to see that you can handle debt. This means you’ll have a higher credit rating if you have borrowed money in the past and met all of your repayments.
So, if you want an excellent credit rating you need to have had debt.
One good way to build your credit rating is to get a credit card and make sure you clear the balance in full each month.
Can you think of any other times where logic and common sense don’t apply to getting the best from your finances? Tell us in the comments below.