Save vs Pay off debts

Just a thought.

Took a loan out for a car a few years back with Zopa with a lending interest of 2.5% (Also take into account of inflation that averages 3-4% yearly)

The question, should I pay off the loan early or save with returns of 5%+.

There is something seriously wrong with the money system when you can borrow cheaper than what you can save.

Should one borrow or save for car ?

If you mean the 5% bonds, note that they do not compound, so in reality they probably won’t keep up with inflation

A simple rule is, if you have existing debts (excluding student loans), you should only save if the savings interest rate is higher than the interest rate of the highest interest debt. In your case, if the 2.5% interest loan is the only debt you have, then you would be better off to save your money in a 5% savings account. BTW, you will need to take the bidding time into consideration. When you are bidding for a bond, your money will have to sit in an account with 0% interest rate for some days or weeks.

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Hi @Gaoler, you are not right to say the 5% bond won’t keep up with inflation. The 5% Dozens bonds have a very good chance to beat the inflation.

First, the Dozens bond interest rate is 5% gross p.a. / 5% AER (Annual Equivalent Rate). When a savings account / Dozens bond pays interest at 5% AER, it doesn’t matter the interest is compound or not. Because 5% AER means that if you put £100 into that account on the first day, and leave it alone for a year, you will be entitled to receive exactly £5 interest in total on the first anniversary, regardless of how is the interest calculated, how often is it paid and to where is it paid.

If you look at other banks’ savings offers closely, you will see many have two headline interest rates. For example, https://uk.virginmoney.com/current-accounts/ shows:

Paying 2.02% AER (2.00% gross per annum variable) on up to £1,000

The reason for that is they pay compound interest, and it’s calculated daily. Therefore 2.00% gross per annual is 2%/365 ~= 0.00548% per day, and compound that over a year will give you: (2%/365+100%)^365-100% ~= 2.02% AER.

In addition to the above, 5% p.a. beats the inflation almost every year in the last nearly 30 years. The Bank of England aims to keep the UK inflation at around 2%, and it’s usually well below 5%. See the ONS data for historical inflation rates here: https://www.ons.gov.uk/economy/inflationandpriceindices

It depends what you think is going to happen with inflation!

We’re at least agreed that a 5% bond won’t keep up with 5% inflation.

Yes, a 5% p.a. interest bond/savings won’t keep up with an above 5% p.a. inflation rate, but I have to say that a persistently above 5% p.a. inflation rate in the UK is extremely unlikely to happen.

Since the UK left the European Exchange Rate Mechanism in 1992, the UK’s inflation rate has been kept at around 2% for ~28 years. The economic went through multiple cycles, and we’ve witnessed many unthinkable events, yet the Bank of England have done a pretty good job at keeping inflation low and steady. There’s no reason to believe Brexit or COVID-19 is going to change that. There may be some short-term high inflation years ahead of us, but a 5% p.a. interest savings account or Dozens bond still has a pretty good chance to beat the inflation.

Of course, it all depends on what are you saving for. To pay off the 2.5% interest loans in a year or two, the 5% bond is a pretty good choice. But planning for the longer term (10+ years), a diversified portfolio is a much better choice than a 5% fixed interest investment.

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