Learn how to borrow safely
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."
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.
An overdraft is an agreement with your bank that authorises you to withdraw more funds from your account than you have deposited in it. Many banks charge for this privilege either as a fixed fee or charge interest on the money overdrawn at a special high rate. Some banks charge a fee and interest. And other banks offer a free overdraft but impose very high charges for exceeding the agreed limit of your overdraft.
Short-term cash loans designed to be borrowed mid-way through the month to tide the borrower over until they next get paid, whereupon the loan is settled. Generally used by people with bad credit ratings and/or no access to short-term credit such as an overdraft or credit card. Like logbook loans, this type of borrowing is hugely expensive: the average APR on payday loans is well over 1,000% and in some instances can be considerably more.
A catch-all phrase that can range from assessing the price of a property or vehicle before offering it for sale or the net worth of assets in an investment portfolio to the prices of shares on a stock exchange.
Generally speaking, insolvency is to businesses what bankruptcy is to individuals. A company is insolvent if the value of its assets is less than the amount of its liabilities, or it is unable to pay its liabilities (loan payments) as they fall due. It’s an offence for an insolvent company to keep trading, so the main options available to an insolvent company are: voluntary liquidation, compulsory liquidation, administration or a company voluntary arrangement.
Changing mortgages without moving home. Property owners chiefly remortgage to get a better deal but some do so to release equity in their homes or to finance home improvements, the costs of which are added to the new mortgage. Even though you’re not moving house, you still need to engage solicitors, conveyancing and the new lender will require the property to be surveyed and valued.
Your credit score is a three-digit number (ranging from a low of 300 to a high of 850) calculated from the information in your credit report. Your credit score enables lenders to determine how much of a credit risk you are. Basically, a low credit score indicates you present a higher risk of defaulting on your debt obligations than someone with a high score. If you have a low credit score, any products you successfully apply for will carry a higher rate of interest commensurate with this risk.
A charge some brokers (and, increasingly, lenders) make for arranging your loan or mortgage, either as a flat fee or a percentage of the amount you wish to borrow. In order to look ultra-competitive in the best-buy tables, some mortgage lenders will offer mortgages with an attractive low rate and recoup any losses with a hefty arrangement fee.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.