Managing borrowing

Recognising types of credit

There are many ways of borrowing money. The two important things are the rate of interest (the APR) and whether you have any extra time to pay if you fall behind.

Bank current account overdraft

An authorised overdraft has the advantage that interest is calculated on a daily basis, so as your pay reaches your account the amount of overdraft, and so the interest on it, reduces. The disadvantage is that the bank can withdraw the facility at any time.

There may be a fee to pay, as well as interest. The usual interest rate is around 5% above bank base rate (the rate fixed by the Bank of England and reviewed each month, at the time of going to press, 5.25%). Avoid unauthorised overdrafts - they can be very expensive.

Bank personal loan

Above a certain amount, a bank will not grant an overdraft but instead may provide a personal loan, which has the advantage that it cannot be withdrawn once started. The interest rate is about the same but is payable on the full amount outstanding.

Credit card

If you time your payments well, you can get nearly two months' free credit. Otherwise, subject to the payment of 10% of the outstanding balance each month, you can have continuing credit - at a cost. The APR on credit cards may be 10% above bank base rate.

Shop credit

Some shops may from time to time offer credit on a purchase. Make sure it is good value for money.

Loan from employer

Some employers make loans available to employees, such as for season tickets, and they may be interest-free. A loan above £5,000 is taxable, but paying the tax on an interest-free loan is cheaper than paying the interest!

Borrowing against a life assurance policy

If you have a life policy and need a loan, this route is well worth considering, as the rate of interest should be lower than a bank loan or overdraft.

Second mortgage

This will be cheaper than other forms of borrowing (about 2% above base rate) because of the security. But there will be charges to pay, so it is only suitable for the longer term.

Re-mortgage

This is an increase in your house mortgage. It is the cheapest form of loan but again there will be charges, so it is a long-term proposition.

Credit checklist

If you intend borrowing money, run through these questions:

What is the interest rate, expressed as APR, and is it fixed or variable?

• How much can you afford to repay, weekly or monthly, and so how long will it take to pay it off the loan?
• Flexibility: can you pay it off early and what happens if you are temporarily unable to pay?
• Is there any other risk? For example, is your home put up as security against the loan?
• Are any fees payable ?

If you are not required to make regular repayments but have to wait till the end of the loan period, open a savings account to build up the repayment.

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