Wealth Check: 'Should I pay back my debt or try to save?'

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Tim Fiennes, 23, was made re-dundant from his consultancy job last October and now freelances for a climate change charity. He hopes to get on the property ladder in his late twenties, and would like advice on whether to pay back his debts or try to save. He has high expectations for retirement, but does not currently contribute to a pension scheme.

"Depending on my salary over the next few years, I would like to save enough to put a deposit on a house in five to eight years' time," he says.

"My main concern is the drop in interest rates on savings."

Case notes

Salary: Tim earns £23,000 a year for his freelance work.
Monthly outgoings: He spends about £750 a month on rent, bills and food, and a further £105 on holidays and membership of a gym. He tries to save about £100 per month.
Debt: He has a student loan of £11,000 and an interest-free overdraft of £1,000.
Savings: £10,600
Pension: £0

Three independent financial advisers offer Tim help this week: Alex Pegley of Calculis, Danny Cox of Hargreaves Lansdown and Gordon Bowden of Quainton Hills Financial Planning...

Good position

"Overall, Tim is in a good position for someone not long out of university," says Danny Cox. "His student debt is manageable and he is earning sufficient to be able to save."

Tim has total savings of £10,600 and the advisers are pleased he has put the maximum amount (£3,600) into a cash ISA for the financial year 2008-09. They recommend that he take out another cash ISA now that the new financial year has begun, to pro- tect more of his savings from tax.

If Tim is willing to forgo quick access to his money for higher returns, he could also deposit some of his remaining savings in a fixed-term bond.

Alex Pegley suggests Newcastle Building Society's 120-day notice account with a current AER of 3 per cent including a 1 per cent bonus for 12 months.

Gordon Bowden suggests a one-year fixed rate bond at 3.6 per cent with First Save, where interest is only paid if the cash is left untouched for a year.

Clear overdraft

Tim should be careful to clear his £1,000 interest-free overdraft before fees or interest start to kick in. Cox suggests that Tim clears it now so as not to get into the habit of operating on a perman- ent overdraft.

The advisers are divided as to whether Tim should use some of his savings to pay off part of his £11,000 student loan.

Historically, the interest rate on student loans has been low enough to encourage people to make minimum loan repayments while putting savings in the bank.

However, interest rates have fallen so low that Bowden and Cox both advise that it could now make sense for Tim to repay some of his loan.

The current interest rate on student loans is 1.5 per cent and Tim would have to get a net return of at least this on his deposits to make saving more worthwhile than paying off the loan. This may be a struggle on his non- ISA deposits.

Cox recommends that Tim "clear his overdraft, then, once he has funded a cash ISA for next tax year, use the balance of £2,400 to clear part of his student loan. This will free up disposable income and leave all of his savings tax free."

Pegley, on the other hand, recommends that Tim does not repay his student loan.

"For certain student loans the interest rate was cut this month to 1.5 per cent and for the year from September 2009 the interest rate will be zero per cent as March's retail price index was nil," Pegley says.

Investment

If Tim is going to wait between five and eight years before buying a house, all of the advisers suggest that he consider taking on some stock market risk.

"The FTSE 100 is trading at historically low levels and as such offers a fantastic opportunity for medium- to long-term investors," says Pegley.

Cox suggests that saving £50 to £100 per month with a stock market ISA - which he can open as well as his cash ISA – would be a good way for Tim to dip his toe in the water. "My favourite equity income funds are Invesco Perpetual Income, Artemis Income, Jupiter Income and Psigma Income," he says.

Bowden suggests a low-cost FTSE tracker fund OEIC or unit trust for saving regularly, while Pegley recommends a structured product such as Keydata's Dynamic Growth Plan Plus issue 16, option 2, which is a five-year investment.

Pension

Tim's aim of working until he is 70 and then living on a retirement income of £30,000 in today's terms is "totally unrealistic given his current level of earnings," says Bowden.

Even if his earnings increase significantly, "future mortgage commitments plus possibly a family will all be a drain on his resources."

Tim should start trying to save for retirement now. Even though he does not have a company pension scheme to contribute to, Tim should try to put a regular sum away.

A small amount such as £50 a month would be a start which he could build on later.

The cost to Tim would actually be £40 as there is tax relief available on the contributions.

For a free financial check-up, write to Wealth Check, The Independent, 191, Marsh Wall, London E14 9RS; or email wealthcheck @independent.co.uk

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