Borrow wisely

Published by on 18 June 2010.
Last updated on 23 August 2011

devil credit card

We're a nation of borrowers. The total UK personal debt stood at a staggering £1,460 billion at the end of March 2010, according to money education charity Credit Action. That equates to an average of £30,258 a person.

But while some credit is bad and can quickly leave you owing far more than you borrowed, credit, when used smartly, can be a useful tool in your financial planning.

Used correctly, a credit card can be particularly useful, Andrew Hagger, spokesperson for Moneynet, explains: "If you can repay your balance in full every month you'll pay no interest.

"Unfortunately many people fall into the trap of only making the minimum monthly repayment each month of around 3% of their balance, which can be very expensive."

For example a £2,000 credit card debt at 12.9% with 3% minimum repayments would take 167 months – nearly 14 years, to clear, stacking up an extra £1,016 in interest.

If repaying the balance each month isn't viable, then look for 0% balance transfer cards. These allow you to switch your balance, usually for a fee of up to 3% of your balance, in exchange for up to 15 months without any further interest charges.

However, watch out for payment hierarchy. "Many card providers use your payments to pay off the balances with the cheapest rate first.

For example, if you transferred £1,000 to your card and then used it for £300 worth of shopping, when you paid £300 on your next statement this would go to repay some of your 0% debt, leaving interest to build up on your purchases," says Hagger.

The good news is that providers will be forced to change their rules by January 2011 so that the most expensive borrowing is repaid first.

For short-term borrowing, an overdraft on your bank account is another option, as long as you've arranged it beforehand.

"Arrange this just in case you get an unexpected repair bill for the car or your pay cheque is delayed," says Hagger. "You'll pay interest charges for the days you're overdrawn but the costs are quite reasonable."

For example, at the average agreed overdraft charge of 14%, being overdrawn by £500 for 15 days would cost £2.87.

"Compare this to unauthorised borrowing on your current account, where being just £50 overdrawn for three days could cost up to £60," Hagger adds.

If you want to borrow for a longer period, perhaps to buy a car, pay for a wedding or to clear some expensive debts, a personal loan is likely to be a cheaper option.

Personal loans allow you to borrow for a longer period, generally between one and seven years, with the monthly repayments fixed for the term of the loan.

There are catches with personal loans though. "Be careful if your lender suggests you take out payment protection insurance, which covers your loan payments in the event of accident, sickness or unemployment," warns Hagger.

"It can be a useful insurance to have but is often more expensive than if you were to go to an independent provider."

Three credit traps to avoid

Store cards
These are an expensive way of borrowing, despite the attractive incentives. Some cards charge close to 30% in interest and even those with lower rates are best avoided unless you can take advantage of the deal and repay the balance straightaway.

Payday loans
Enabling you to borrow money for the short term, while the amount you pay may seem relatively low, the APRs can be extortionate. For example, borrowing £100 for five days could cost you £25 – an interest rate of 1,737%.

Hire purchase agreements
Also known as a conditional sale agreements, this is a common way to purchase big ticket items such as cars or furniture. The rates aren't necessarily bad but the terms are more restrictive. Unlike credit, you don't legally own the goods until you've paid back all the money. This means you can't sell the item and, if you fall behind on payments, the retailer can ask for it back.

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