Martin Lewis gave vital advice for anyone with a credit card (Image: ITV)
Personal finance expert Martin Lewis has issued vital advice to anyone holding a credit card with providers such as Lloyds Banking Group, Barclaycard, Santander, Tesco Bank, American Express, NatWest, and HSBC. Mr Lewis warned that making just one mistake could leave people facing crippling interest rates – and that a single penny could make all the difference.
The money-saving guru tackled the subject on his BBC Podcast, responding to a listener’s query regarding the most effective approach to managing savings. He used a £1,000 example to demonstrate and explained: “This is an important warning about the way that credit cards work. Imagine you’ve spent £1,000 on the credit card.
“If you then pay off the £1,000, so you totally clear it, there is no interest in the month. But if you were to pay off £999.99, so you’re just a penny short. You don’t pay interest on a penny for the month. You still pay interest on the entire £1,000. This is why for years my catchphrase has been pay off your credit card in full.
“The in full is important. I talk about it when it’s a credit card reward, say for getting cash back or for cheap spending on a credit card abroad. Because if you do it in full, you neuter the credit card’s ability to charge you interest. If you miss even a penny, it can still charge you a whack.”
Caller Dan asked: “You’ve talked about whether you should pay off any debt before savings and investing. Does this apply to mortgages.” Mr Lewis explained that the crux of the matter was determining whether someone would benefit more from deploying their funds elsewhere.
He replied: “My general advice about debt is you should always pay off expensive debt before saving. It does get a little bit more contentious because you also want to have an emergency fund.
“It depends on the nature of the debt that you pay off. The emergency fund is there so you don’t have to pay off even more. Credit cards are quite simple because they are an open-ended system of borrowing.”
“So if you think about it, if you’ve got £1,000 on a credit card and you’ve got £1,000 in savings, the credit card is costing you 20 per cent, the savings are gaining you 4 per cent. You gain 16 per cent if you use the savings to pay off the credit card.
“And the advantage with the credit card is once you pay the credit card off it can sit there at a zero balance and if you have an emergency because you now don’t have any savings you can just borrow back on the credit card and you’d be in no worse a position but you would have saved the interest meanwhile.”
This means that someone carrying £3,000 on a credit card would incur charges of £600, while having £3,000 in savings would yield just £120.
Addressing the topic of mortgages, he explained: “The general rule of thumb is this – if the mortgage rate is higher than the after-tax rate you can earn on savings – so let’s say you’ve got a 6 per cent mortgage and then 4 per cent in savings – then you are generally better to overpay the mortgage, making sure the payments go towards reducing your capital which will effectively reduce the amount of time you have left to pay on the mortgage.
“If the savings rate is higher than the mortgage rate, then you are probably better off to save – with a couple of caveats. First of all I’d go on to a mortgage overpayment calculator because if it’s very close between the two generally overpaying your mortgage will win because of the vagaries of the way interest is worked out.
“But also if you reduce the amount of your mortgage debt, if you’ve got quite a high proportion of borrowing to your house’s value if you reduce the amount of your mortgage’s debt, you reduce the loan to value which could mean you get a cheaper mortgage when you come to remortgaging.
“The two big caveats to overpaying your mortgage are – first of all I’d always have an emergency fund in liquid cash because if you overpay your mortgage and suddenly something happens that you can’t pay it any more, that’s not going to start the bank going ‘oh you’ve overpaid so don’t worry about paying us now’. They’re still going to put you in arrears.
“And second you need to check that there aren’t any overpayment penalties.” He added that typically, lenders permit borrowers to overpay up to 10 per cent without facing charges.