The best ways to borrow
While the credit crunch means that most of us are tightening our belts and cutting down on spending, there are still circumstances – from replacing the car or mending the roof to the family holiday – in which we may need to borrow money.
At the moment, personal borrowing is levelling out. According to the debt charity Credit Action, total UK personal debt reached £1,459 billion at the end of March 2009. Figures from the charity also show that the average household debt in the UK (excluding mortgages) now stands at £9,280, down from £9,550 at the end of January.
Meanwhile, average consumer borrowing using credit cards, motor and retail finance deals, overdrafts and unsecured personal loans, fell to £4,850 for each UK adult in March from £4,870 in January. However, March’s figures are marginally higher than February’s, suggesting we have not dramatically cut back or made inroads into our debts.
If you find yourself in a situation where you need to borrow money, where should you go? There are a number of options available to you, including personal loans, credit cards and overdrafts. Each has its pros and cons, and it’s important to look at these before deciding which type of borrowing is best for you.
Personal loans are either ‘secured’ or ‘unsecured’. Secured loans require you to provide some sort of collateral as security. You can use a car or other property as collateral, but using your home is the most common way to obtain a loan, so you will need to have sufficient equity in it to be eligible.
Secured loans are cheaper than unsecured loans, but there are more risks involved. As your property is the security, if you default then your house may be at risk of repossession.
To find the best secured loan rate for you, visit a price comparison website such as uSwitch.com or moneysupermarket.com.
Tim Moss, head of loans at moneysupermarket.com, says: “For those people with a healthy income, plenty of equity in their home and, perhaps, only one or two blips on their credit record, a secured loan can be a good option, with the ability to borrow more at a lower rate.”
If you don’t own your own property – or don’t fancy having another loan as well as your mortgage secured against it – then an unsecured personal loan could be the answer. However, rates on unsecured loans have increased over the past year.
According to MoneyExpert.com, the average rate in March 2008 was 10.4% rising to 13.2% in the same month 2009. Best buys tend to be between 8% and 10%.
You can search for unsecured loans on price comparison websites or by using Moneywise's personal loan Loan comparison service.
For both secured and unsecured loans, the loan amount will be paid into your bank account and you then pay monthly instalments, usually by direct debit. Bear in mind that the longer the loan term, the more interest you will pay in total.
For example, if you borrow £10,000 over fi ve years at an APR of 7.9%, you’ll have to pay back £200.99 a month, which comes to a total of £12,059.19. If you borrow the same amount at the same interest rate over seven years, your monthly payments will fall to £154.01 but you’ll pay back £12,937.12 altogether, which is £877.93 more.
In some cases, you may be in a position to repay the full loan amount early. However, your loan provider might charge you an early repayment (or redemption) charge for doing so.
This should be no more than two months’ interest on the outstanding amount. Not all loan providers charge early repayment fees, so check the small print before you sign.
When you take out a loan, make sure you can afford the monthly repayments as missed payments can result in extra charges. Moneynet spokesperson Andrew Hagger says: “The lender will usually charge an unpaid fee of between £25 and £35, and write to you asking for funds to be paid in so that the payment can be taken in seven days’ time.
"If it's cleared at the first time of asking then it’s unlikely that your credit record will be impacted, but if you fail to make up the payment within the seven-day period there’s a good chance that it will be reflected on your credit file.”
Credit cards allow you to pay for items on your card and repay the provider at a later date. They’re useful flexible friends, but only as long as you use them sensibly.
Credit cards normally come with an interest-free period of around 45 to 59 days from the date of purchase, which you can use as a breathing space before repayment. If you repay the full amount outstanding each month, you won’t ever pay any interest.
But if you have an outstanding balance on the card after the interest-free period has ended, the card provider will charge you interest at the card’s APR.This stands for annual percentage rate, and is a way of expressing the true cost of borrowing in terms of interest and fees.
A 'typical' APR must be shown on all advertisements and marketing material for loans and other forms of credit, so customers can easily compare different products. However, the 'typical' APR might not be the rate you receive, as this will depend on your credit profile.
Credit cards have APRs at anything from 5% up to more than 30%, so it’s important you check this before picking one. Unlike personal loans, there’s no set monthly repayment on credit cards – you can pay back as much as you want each month, which makes them a flexible way to borrow.
But that flexibility can also be dangerous if you let your debt mount up. You will have to make a minimum monthly payment, typically 2% or 3% of the outstanding balance. If you fail to do so, you’ll incur a penalty charge on which interest is also charged.
Some cards offer introductory deals where the interest rate is set at 0% on purchases for a certain number of months. These are worth going for – but make sure you pay off the debt before the introductory offer ends.
Other credit cards offer 0% on balance transfers to entice cardholders to switch existing card debts to their card. However, there is usually a fee for doing so, typically 3% of the debt. Switching an existing debt to a 0% balance transfer card means your repayments will all go towards paying off the capital you owe, rather than interest payments.
One type of credit card to watch out for is the store card. These work like credit cards, except that they can usually only be used with certain retailers. Shoppers are often tempted to take out these cards as they usually offer a discount on the fi rst purchase on the card, but the APRs on store cards tend to be well above typical credit card APRs, so you should try to steer clear of them.
If you are making a large purchase, some retailers also offer in-store credit. But this too can be an expensive way to borrow money.
A current account overdraft is another way to borrow money, this time from your bank. An overdraft is basically the amount of money you can still access when you have no money in your account. So if you have a £1,000 overdraft limit you can keep spending up to that limit.
You will be charged interest on the amount you are overdrawn, although some banks offer 0% overdrafts for a certain period of time or up to a certain limit. Most of the big banks offer overdrafts.
If you are a student, for example, you will typically be offered a £2,000 overdraft in the hope that you will stay with the bank when you become an earner.
If you exceed your overdraft limit – which can be negotiated with your bank – you will be borrowing money through an unauthorised overdraft. Banks ramp up the interest rates on unauthorised overdrafts, and there could be a penalty fee to pay too.
“It’s always far cheaper to borrow via an agreed overdraft limit as opposed to an unauthorised one,” says Hagger. “The average rate for authorised overdrafts is 14.5% but for unauthorised it’s 24.9% plus hefty overdraft fees of £25 or £30 a time.”
Overdraft rates vary between different banks and accounts, so check before you open an account. “If you are getting close to your overdraft limit each month, it’s worth contacting your bank to arrange an increase to give you some added breathing space,” says Hagger.
“Even though authorised overdraft interest rates have increased, they are still far cheaper than unauthorised borrowing.”
Credit to avoid
As well as overdrafts, loans and credit cards, there are also a number of other ways to borrow money. But be warned: products such as payday loans, logbook loans and doorstep loans come with high interest rates and strict penalties should you miss a payment, and you should avoid them.
Payday loan firms typically charge £25 for every £100 borrowed, and you have to pay the money back within a month. Although this might sound reasonable, the charges can spiral if you cannot pay the money back when it’s due – they can equate to an APR of more than 1,000%.
These sort of lenders target people with a poor credit history who might struggle to get credit
elsewhere. If this applies to you then it makes sense to get professional advice about your debts
rather than borrow more money at unaffordable rates.
Question to ask the lender:
* What is the APR?
*How long is the term of the loan?
* How much will I be repaying in total?
* Are there any early repayment charges?
* What happens if I miss a payment?
* Will my house be at risk if I can’t repay the loan?
* Is there an arrangement fee?
* Is the interest rate fixed or variable?
Questions to ask yourself:
* Do I really need to borrow this money?
* Can I afford the repayments?
* Would a credit card or overdraft be a cheaper way of borrowing?
* Am I likely to be in a position to repay the loan early?
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 homeowner’s worst nightmare; repossession is an action of last resort by mortgage lenders to recover money from borrowers that have failed to keep up with repayments on their mortgage or other loan secured on their home (see secured loan). Repossession is a legal procedure that has to go through several processes before the homeowner is evicted and the property reposed. These are: if a borrower keeps defaulting; the lender applies for a solicitor’s notice; the lender instigates possession proceedings through the court; at the court hearing a possession order is granted and sometimes a possession warrant; a bailiff is appointed and an eviction notice issued at which point the homeowner has two to three weeks to vacate the property.
As the name suggests, secured loans require security, or “collateral”, usually in the form of property, a motor vehicle, or another valuable item, as a guarantee for the loan. This effectively reduces the level of risk to which a lender is exposed, as the lender has a claim against your home, or other effects, if you default. Secured loans are often available at competitive interest rates. Types of secured loans include mortgages, logbook loans and some types of hire purchase where the loan is secured on the goods you’re buying and these are repossessed if you default.
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.
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.
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.
Moving money from one account to another, whether switching bank accounts or more likely transferring the outstanding balance on your credit card to another card that charges a lower – or 0% – rate of interest. Some card providers may charge a transfer fee that can be a percentage of the balance transferred.
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%.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.