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Practically everybody living in the UK today has, or has had at some time or other, some type of credit agreement, whether this is in the form of a personal loan, overdraft, credit card or mortgage.
The majority of borrowers are likely to be able to tell you broadly how each method of borrowing differs from the others and also what the similarities might be, as well as probably have a reasonable idea as to what the relative costs of each method may be.
Despite this vast wealth of apparent knowledge, many people still find it difficult when it comes to choosing the best method of borrowing to suit their particular needs and requirements and also when it could be advantageous to take out one form of credit over an alternative method of borrowing.
In this article, we aim to look at the various alternatives which are available for someone needing additional money, along with the advantages and disadvantages of each option.
One of the most important factors to take into account is how long a term the borrowing is going to be over.
Overdrafts
For short term borrowing, for example, funds to see you through until the next pay day for a week or two, then an overdraft is probably the best option. Although the interest rate charged on overdrafts tends to be one of the highest rates around, the borrowing is usually only for a short period and therefore the cost is minimal. Also, if you have an authorised overdraft facility on your current account, this can be used whenever required, without having to apply for the credit and you do not have to give a reason for the borrowing to your bank.
Some types of current account will allow a free or reduced rate overdraft on small amounts, but with any account, if you exceed the agreed facility level and use an unauthorised overdraft, then there are likely to be penalties and a higher interest rate charged. If your account is constantly overdrawn, then it may be more cost effective to consider an unsecured loan instead, as this will certainly be a cheaper option.
Credit Cards
Credit cards have become extremely popular over the course of the last few years and most people have such a card, even if they tend not to use it. Credit cards can be extremely useful for things like emergency bills, or repairs, which were unexpected and therefore not budgeted for. They are also very useful for making large or expensive purchases, such as expensive household items or holidays, as most credit cards offer insurance as a built in part of the facility.
However, as with overdrafts, credit cards are usually a rather expensive way of borrowing money and as such should be treated as a short term borrowing solution. With most cards, if you clear the full balance every month as the bill arrives, there will be no interest charged, but if you allow a balance to build up, the interest can be extremely expensive and the minimum monthly repayment will probably only just cover the interest charge.
Many credit cards now offer 0 per cent balance transfers from other card providers for a limited period, usually up to 12 months, which can save a large amount of money in interest payments, but there is often a fee for doing this. Credit cards must be used with care, too many people have got themselves into an awful lot of trouble by running up large balances on cards, which they then have no way of repaying, so be careful.
Loans
When it comes to borrowing money, the first thought most people have is to take out a personal loan of some kind, and usually this is the most appropriate route to take for things such as purchasing a new car, or making home improvements, for example.
The problem is that there is such a wide choice of personal loans available in the market place, not only between different providers, but also in the amount to be borrowed and whether to choose a secured loan or an unsecured loan.
Generally, unsecured loans are used to borrow smaller amounts of money, usually up to a maximum of £25,000 and these run over a shorter term than secured loans, usually up to a maximum of 7 years.
In many cases the rate of interest charged on an unsecured loan becomes cheaper as the loan size, or term increases. Therefore, a loan of £3,000 is likely to charge a high rate of interest, whereas a loan of between £5,000 and £10,000 is likely to be cheaper and a loan in excess of £10,000 will be cheaper still.
However, don’t be tempted to borrow more than you actually need, just because the rate is cheaper, as the money plus interest all has to be paid back eventually! When choosing what term to take the loan over, it makes sense to keep it in line with the item being purchased.
For example, if you change your car every four years, then a four year term would be appropriate on the loan. A personal loan to pay for a holiday however would make more sense over a 1 year term, as you will probably want another holiday next year as well and you don’t want these debts to mount up.
Secured loans work on the same principal as unsecured loans, apart from the fact that the lender takes some kind of security against the loan, usually the borrower’s house. This means that if the borrower defaults on the loan, the lender has the right to reclaim the outstanding debt, plus costs, from the secured property in question. This means that it is possible to lose your home if you opt for a secured loan.
Secured loans are usually used for major expenses, such as major home improvements, or extensions, or even in some cases debt consolidation and often run for a much longer term than an unsecured loan, often up to 25 years or possibly longer. As a result of this higher lending amount and additional security for the lender on the loan, a secured loan usually charges a lower rate than that of an unsecured loan, but will cost significantly more over the term due to a larger loan amount and much longer repayment period.
A mortgage, or homeowner loan, is the cheapest rate and longest term loan available and for most people it is the only way that they are able to purchase their own home.
The typical term is for 25 years, but this may be shorter or longer than this, often depending upon the age of the applicant. A mortgage o homeowner loan is exactly the same as a secured loan, except that it takes a first legal charge on the property in question rather than a second charge, as in the case of a secured loan.
This makes the loan a better risk for the lender, as they will have first call on any money from the sale of the property in the case of a default on the loan. There are many different types of mortgage product available and it is worthy seeking professional financial advice before choosing a suitable product, to ensure the loan taken is the most suitable to meet your needs and requirements.
To conclude, there are many different options available when it comes to borrowing money and you should think extremely carefully, checking out all the various alternatives before committing to any one particular route.
If you are in any doubt about what you require, it is worth taking the time to seek professional advice from and independent financial adviser. Even if the adviser charges you a fee for his services, it could save you a lot of money in the long term.
Don’t make any snap decisions when it comes to borrowing money, think about how much you actually need to borrow and also about your ability to be able to repay the debt in the future. Once you have decided on a particular route, be careful to read all the small print before signing the paperwork, ensuring that you fully understand exactly what you are getting into.
And finally, borrowing money in any way is an expensive thing to do, so if you don’t absolutely need to do it, then don’t borrow!
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