Learn how to borrow safely

Last updated: Aug 23rd, 2011
Feature by Esther Shaw

No matter where you look, we have become a nation of borrowers, used to having cheap and easy credit at our fingertips.

In fact, the average consumer borrowing, via credit cards, motor and retail finance deals, overdrafts and unsecured personal loans, was £4,430 for each adult at the end of October this year, according to money education charity Credit Action.

But while borrowing can be a great way of managing your finances, it can all too easily spiral out of control.

New figures from debt charity the Consumer Credit Counselling Service (CCCS) show a record number of people got in touch with it last year, with its helpline receiving 335,323 calls during 2009, while Citizens Advice dealt with 2,374,273 debt queries in 2009/10, an increase of 23% on the previous year.

Statistics such as these make for chastening reading, but borrowing doesn't have to be a bad thing – provided you do it wisely.

If you do need to raise money, there are plenty of options available. The best one for you will depend on how much you need to borrow, how soon you can repay it, how disciplined you are – and on your credit score.

Choosing the right borrowing option could save you hundreds of pounds in interest – and prevent your debts taking over – so it's worth taking the time to find the best way of raising finance.

1. Borrowing £200 to get you to the end of the month

Nearly four in ten people struggle to make it to the next payday, according to a recent report from R3, the Insolvency Practioners trade body. But if you run out of cash just before the end of the month, how should you go about bridging the gap?

Scores of companies offering payday loans – temporary handouts of between £80 and £800 to tide you over until next payday – have sprung up in recent years.

But while these firms offer what looks like easy access to cash, with a loan decision often given in minutes, the charges can be extortionate, so it's best to steer clear.

For example, If you borrowed £200 from payday loan company Payday UK, it would cost you £50, meaning you pay back £250 in total. This gives a typical annual percentage rate (APR) of 1,737%.

Borrowing £200 from Wonga.com for 30 days will cost a total of £266.31, giving a typical APR of 2,689%.

If you only need to borrow a small amount of money for the short term, an overdraft is the best option.

According to comparison website Moneyfacts.co.uk, the average authorised overdraft rate stands at 14.22%. So if you were to approach your bank and arrange an overdraft facility of £200, there would be no set-up fees and with the market average rate of 14.22% the interest costs to borrow this amount for two weeks would be just over £1.

Furthermore, while many banks charge double-digit interest, you can easily switch elsewhere to an account such as Santander's Preferred Overdraft Rate account, which offers a 0% overdraft for the first 12 months.

Nonetheless, with any account, you do need to keep a close eye on how near you're getting to your agreed limit, as you risk incurring charges if you dip into your unauthorised overdraft.

If you're savvy, one of the best ways to deal with this payday shortfall is by putting any purchases on a credit card offering a 0% introductory purchase deal.

Tesco Bank, for example, is currently offering 0% on purchases for 13 months, while Sainsbury's Finance and Barclaycard Platinum are both offering 0% for 12 months.

However, you need to be disciplined about paying off the balance before the interest-free period expires, either through monthly payments or by putting money aside in a savings account, so the balance can be cleared in one go before interest is charged.

If you find yourself borrowing to get to pay day, it's worth reviewing your finances.

2. Borrowing £3,000 for a new car

Unless you're in the enviable position of having the cash put aside to buy a car outright, you may be considering funding your new set of wheels with dealer finance.

Many dealers have interest-free deals on new cars, but if you go down this route, you'll pay the full price, rather than being able to negotiate a discount, and you'll also need a good credit record, a substantial deposit, and the ability to make large monthly repayments to qualify.

If interest-free credit isn't possible, you could consider hire purchase or personal contract purchase (PCP).

With hire purchase, you'll usually need to put down a deposit to the dealer's financial arm of around 10% to 20%, and then make monthly payments over three to five years.

After the final payment, the car will be yours. Whereas with PCP, the initial costs are lower, but when the payments end you must either hand back the car or the lump sum.

As a buyer, you may be tempted to look no further than the options offered by the dealer, but be very careful about signing up to forecourt finance as the package may not be quite as attractive as it first appears.

The key is to check the total amount payable and compare this with a loan from a high street bank or building society – as this could offer better value.

You also need to be wary of making multiple applications as this could have a negative impact on your credit rating – and could reduce your chance of being accepted for a loan.

At present, loans for smaller amounts tend to be more expensive. Figures from Moneyfacts.co.uk show that if you were to borrow £3,000 over a 36 month period with an average 13.9% APR, you would pay back £101.21 per month, equalling £3,643.56 overall.

3. Borrowing £20,000 for a new kitchen

Mortgages are not just for buying houses, and if you're looking to borrow a significant sum to carry out home improvements, it's worth looking into additional borrowing on your home loan.

"Historically, one of the easiest ways of raising £20,000 to pay for a new kitchen, for example, was to add the cost to your mortgage – either through a further advance or by remortgaging the entire loan," says Melanie Bien, marketing director for broker Savills Private Finance.

"But the situation has changed since the credit crunch. If you have significant equity in your home – say, more than 40% or 50% – a lender should still agree to the extra borrowing, but if you have little equity, you could struggle."

If you do have enough equity in your home, ask your existing lender whether it will increase your mortgage by the required amount.

"If your lender agrees, you will be offered the borrowing at a different rate of interest from that which you're currently paying – and this is likely to be higher," says Bien.

"Usually, you would pay this back over the same length of time as the rest of your mortgage, but some lenders may let you opt for a different loan term."

There are no legal costs to pay, but there may be an arrangement fee, and the lender may require a valuation of the property, which you would also have to pay for.

Some lenders also have a minimum amount that you can raise; others don't, but will charge a higher fee if you are borrowing less than £50,000.

"Alternatively, if you don't have any redemption penalties on your mortgage, you may be able to remortgage the entire loan, raising enough to cover the additional borrowing," says Bien.

The key is to ask your lender what rate it can offer you and then compare this with what else is on the market. The alternative to additional mortgage borrowing for a sum of this size is a personal loan.

Unlike a mortgage, a personal loan is not secured on your property, which means it can be arranged in a matter of days. However, while there are no upfront fees, the rate of interest will be higher.

The interest rate and monthly repayments would be fixed for the period of your loan, with the maximum term typically seven years for a loan of £20,000. You can usually repay the loan whenever you like, but, like a mortgage, it may be subject to earlly repayment charges.

Sainsbury's Finance is offering a personal loan at 7.7% and Nationwide is offering a rate of 7.6%. So, for example, if you took out a £20,000 loan over seven years with Sainsbury's Finance, you would pay £292.50 per month, with the total repayable standing at £26,325.00.

Your Comments

a company call to give a loan of £3000 to pay in 36 months i needed to pay buy instalments of £97 each month i paid the first instalment cos they sad it was for a secure instalment with a ukash voucher it is true i have to pay an extra £250 for a VAT and then be refunded the VAT money or is just a scam i already paid £97 yeasterday by a ukash voucher but then the man i spoke told me i needed to pay the VAT of £250 cos i dont have a good credit history it is true or not please can you help me? thanks

No its not true - it's a scam - it happened to me - these people (usually Indian/Pakistani using English names) use the address of legitimate companies to make you think the real - then they ask you to pay by Ukash - which is like cash money which you will never get back - and they just keep asking for more money all the time for this and for that and you never get ur original loan - it happened to me and I lost £300 - when i called the company they told me straight away that its a scam and the scammers have been using their address and do not give them any money - unfortunately by that time it was too late!! so beware!!