Five forms of credit to avoid at all costs
Paying for Christmas on credit could end up costing you dearly as lenders hike rates on loans, credit cards and store cards.
It is anticipated that, despite the credit crunch, people will still be borrowing this year in order to celebrate Christmas in the manner they have become accustomed to. Although there is an argument for using some types of credit to sensibly balance the cost of Christmas and protect your purchases, you’d be wise to be on your guard against high APR loans and plastic with high interest rates.
There are five main forms of credit that should be avoided wherever possible:
1. Pay day loans
Google 'pay day loan' and you’ll get a whole list of companies willing to lend people between £100 and £1,000 ,which doesn't have to be repaid when they pay day. While this might seem an easy and relatively safe way to borrow, interest rates are often a staggering 1,355%. So although you don’t have to have a credit check to take out this type of loan, you could end up seriously in debt despite only borrowing a relatively small amount.
Andrew Hagger, of moneynet.co.uk, says: “Unless you know for certain that you’re in line for a windfall from some other source, it’s sheer madness to borrow in this way.”
Research from price comparison website uSwitch.com show that someone borrowing £750 from one pay day loan company, which has an APR of 9889.3%, could end up paying back up to £1687.50 if they defer repayments for a total of five months.
Louise Bond, personal finance manager at uSwitch.com, says: “Some companies will allow consumers to defer repayment for several months, which can rack up a phenomenal amount of interest. The current economic climate is perfect for these organisations to lure in unsuspecting cash strapped consumers that are often so desperate, they really don’t care how much interest they have to pay.”
2. Log book loan
Log book loans allow car owners to borrow between £500 and £50,000 by using their vehicle as collateral. In most cases, the lender will not run a credit check and many will allow you to borrow against the value of your car even if you bought it on a finance deal.
The catch is the APR – these are typically 430%. This means a loan of £1,500 will turn into £1,845 in just one month or £4,180.00 if you defer payments for 78 weeks.
Hagger says: “If you can’t keep up with the repayments, you’ll lose your car. Sheer lunacy.”
3. Credit card cheques
The current climate has highlighted the danger of spending on credit without any plans as to how you will pay off the debt. But despite this, credit card companies continue to send out cheques that enable card-holders to make purchases from organisations that don't accept credit cards.
While this might seem an ideal way to buy products or services from firms that don’t accept plastic payments, interest rates tend to be around the 30% mark. The provider will also charge you a handling fee, typically around 3%.
4. Credit card cash advances
Another trap many credit card-holders often fall into is using their plastic to withdraw cash. APRs on cash advances tend to be expensive across all deals and with no interest-free period, your debt will start increasing from the moment you punch in your pin.
And, as Hagger points out, people with 0% balance transfer or purchase deals will still face interest of around 27% if they withdraw cash.
5. Unauthorised overdrafts
If you exceed your overdraft limit without permission from your bank then you face being hit with hefty charges. The test case on bank charges may mean banks will have to reduce these in the future, but until then you should check your bank statements as often as possible to ensure you don’t slip into the red unwittingly.
It might also be worth applying for an overdraft facility from your current account provider in advance as a safety net should you accidentally overspend.
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.
An unexpected one-off financial gain in cash or shares, generally when mutual building societies convert to stock market-quoted banks. Also windfall tax, a one-off tax imposed by government. The UK government applied such a measure in the Budget of July 1997 on the profits of privatised utilities companies.
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.
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.
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%.