Borrowing and credit basics
Nearly everyone will need to borrow money at some point in their life, whether it’s for a student loan, a car, or to pay for a first home. We look at the range of borrowing products available to those aged 18 and over and explain how they are best used.
Borrowing products – what’s available from age 18
There’s quite a range of borrowing products available to people aged 18 and over, and while it’s illegal to lend money to anyone in the UK aged under 18, you can still easily get into debt.
All forms of borrowing charge interest, which must be displayed for each form of borrowing as an Annual Percentage Rate (APR). This is so people can compare the cost of different products.
Below are some of the most common forms of borrowing – we’ve arranged them in approximate order of the APR charged, with the lowest APR at the top and the highest at the bottom.
- Personal loan – This is usually a fixed amount, say £1,000, borrowed over an agreed period of time. The loan is repaid in monthly instalments until paid in full at the end of the period. This is one of the cheapest forms of borrowing.
- Overdraft – Your bank account provider allows you to take out more money from your account than you have in there. This is supposed to be a very short-term form of borrowing, as the next time money (income) is paid into your account it will reduce or even clear the overdraft. Some bank account providers offer interest-free overdrafts. Be aware that if you go overdrawn without the permission of the bank, the charges may be very high.
- Credit card – A card used to purchase items. The money doesn’t come out of your bank account – instead you receive a statement of your borrowing at the end of each month. You then have the option to pay off the full balance on the card (i.e. the total of what you have spent), or as little as 5% of the balance. If you choose not to pay the whole balance, you’ll be charged interest on the balance left on the card – this is then added to your statement for the end of the next month. If you only ever pay off 5% of the balance of a credit card it will take far longer and cost far more to repay.
- Credit unions – Small financial organisations set up by their members to support the local community. They offer small loans of typically £3,000 or less and are generally far cheaper than payday loans. By law the maximum interest rate a credit union can charge its members is 3% a month or 42.6% a year APR (the cap in Northern Ireland is 1% a month).
- Store cards – These function in a very similar way to credit cards, with the key difference being that you can only use them in stores that belong to the same group. They’re not as flexible as credit cards and tend to be more expensive because they usually have a higher APR.
- Payday loans – Very short-term loans, intended to provide you with money until your next payday. These loans have extremely high APRs and some equally high penalties for missed repayments. All other forms of borrowing should be looked at before considering a payday loan.
When should you borrow?
There is a school of thought which argues that debt can be classed as either good debt or bad debt.
Good debt – any borrowing that enables you to make money or improve your prospects in the long term, such as buying a car so that you can travel to work, or a student loan, is classed as good debt, as long as it is manageable for you to make the repayments.
Bad debt – any borrowing that provides no return at all, such as borrowing to fund luxury items or expensive trips, is bad debt.