Toolkit 2 Borrowing Wisely

Transcription

1 Toolkit 2 Borrowing Wisely

2 Questions to Think About Before Borrowing Borrowing money is not necessarily a bad thing and done sensibly it can be a good investment for your future. Some good reasons to borrow money include buying a home, paying for education, to deal with an emergency (e.g. burst pipe or broken down car), or to pay off debt at a lower interest rate. However, borrowing money in some situations can be a bad idea, costly, and can present a lot of risks. It is a decision that should not be taken lightly or on the spur of the moment, but should be fully researched and informed. Before borrowing think about: What sort of things do you consider before borrowing money (if anything!)? How do you decide how much to borrow? Do you take time to think about borrowing or just borrow straight away (e.g. buy a purchase on a credit card on impulse or take days to think about it)? What attracts you to certain types of borrowing Do you NEED to borrow money? Can you afford to borrow money? Do You NEED to Borrow Money? When deciding whether or not you need to borrow money you should think about the following: What do you want to borrow the money for? Is the item or service essential or could you do without it? Do you REALLY need it? Do you really need the item or do you just want it? Is there a cheaper option available (e.g. a second hand items, free recycling websites, auction sites, discount stores etc.)? Is this a spur of the moment decision? Will you feel that this is as important/ essential in a couple of days? Is there an alternative to borrowing? Do you have savings that you could use rather than borrowing money? Note: If you spend money from savings on an item you will no longer be accruing the interest on that money. However, it is likely that you would accrue much less interest on savings than you would need to pay on borrowing money. For example, the interest on your savings might be 3% (which you accrue), but the interest repayments on a loan or credit card might be 17.5% (which you lose). Can you save for the item/service instead or do you really need it now? Can you wait until you can afford it rather than borrowing money?

3 Is there another way you could get the money e.g. doing a clear out and raising the money by selling off redundant items? Is there another way of getting the item e.g. can you swap it for something else? Can you get a free upgrade? When deciding whether you need to borrow money you should also think about whether the debt is a good debt or a bad debt Can You Afford to Borrow Money? Essential to deciding whether to borrow money is ability to pay it back. You must be able to afford the repayments so need to work out what you can afford to repay and over what timescale before making any borrowing commitments. To do this you must work out your weekly or monthly budget so that you know how much there is coming in and going out. This will help you to understand what additional payments we can realistically afford on top of those we currently pay. If you have more money coming in than going out you may be in a position where you can borrow. However, it is important where possible to leave yourselves with contingency money for any unexpected expenses or change of circumstance and not to allocate all surplus income to paying off borrowings. It is essential to consider the full costs of borrowing when working out whether you can afford it. This includes interest payments, penalties, administration charges and so on. Ensure that the borrowing option meets current and (where possible) future needs. Consider the impact that borrowing money may have on the future, for example, if it is going to take a long time to pay it off what impacts might this have, if circumstances (e.g. a drop in income) or interest rates change? If you want to pay it off early is there an early redemption fee?

4 Borrowing: Healthy & Unhealthy Debt1 When thinking about whether you need to borrow money you should think about whether the debt will be Healthy Debt or Unhealthy Debt. Comparison Healthy Debt Unhealthy Debt What is it? In simple terms, a good or healthy debt is one that is a sensible investment in your financial future should leave you better off in the long-term and should not have a negative impact on your overall financial position. Repayment You will have a clear and specific reason for taking it out, and a realistic plan for paying it back that allows you to clear the debt as quickly as possible, or in a series of regular and affordable payments (e.g. for a mortgage). Considerations Someone with a good debt will also have identified the cheapest possible way of borrowing that money. They will have done this by finding the borrowing method, an interest rate, loan or credit amount, term and charges that are the most appropriate for them. In some cases it will mean a deal with the lowest possible interest rate, but in others it may not, for example if the lowest rate comes with the price of high charges or penalties. Bad or unhealthy debts are those that drain your wealth, are not affordable and offer no real prospect of paying for themselves in the future. Bad debts are also likely to have no realistic repayment plans, and are often run up when people make impulse purchases of items they don t really need, or borrow money to pay every day bills. If you can t afford to borrow the money (for example, you aren t sure you ll be able to make the monthly repayments) it is definitely a bad debt. Tips to Avoid Unhealthy/Bad Debt: When considering borrowing money, ask yourself the following questions. If any of the answers are no, that debt is likely to be bad/unhealthy. Will borrowing this money improve my finances in the long run? Have I shopped around to get the best deal? Am I borrowing this money as cheaply as possible? Will I be able to cope should interest rates rise in the future? Will I comfortably be able to afford the monthly repayments? Do I understand all the terms and conditions associated with borrowing this money? Do I understand the risks and what could happen if things go wrong? 1 The following information has been adapted from the Money Advice Trust information available at

5 Borrowing: Types of Credit There are many different types of credit which can be used in different situations. Personal Loan: This is a loan you may get from a bank, building society, credit union or finance company. It is usually a fixed amount, borrowed over a fixed period of time (the term of the loan) and paid back in monthly instalments usually by direct debit. You will be charged a rate of interest and sometimes fees. Interest rates are usually fixed (the interest rate and amount you repay will not change), but some personal loans charge a variable interest rate (the interest rate may go up or down during the term of the loan, changing the amount you repay). Secured Personal Loan: This is the same as a personal loan above, but with difference of being secured. This means that an asset (usually your home) has been used as security against the loan in case you can t pay the loan back. The interest rates can be cheaper but it can also be a risky option. If you don t keep up the repayments on a secured loan the asset offered as security (e.g. your home) may be at risk. Secured loans are usually used to borrow a large sum of money. Credit Cards: This is a card that allows you to buy things or even withdraw cash on credit. Interest is charged if the full cost of what you have bought or withdrawn is not paid back before the end of each month. There are usually higher charges and often a handling fee for withdrawing cash than for buying things. Interest rates on credit cards are typically high making it an expensive way to borrow. However, if you pay off your balance or borrowing in full each month you pay no interest. You can pay the money back when it suits you, but will usually have to pay a minimum amount based on the balance shown on a statement every month. Paying only the minimum payment will hardly cover the interest and will prolong the debt. Overdraft: A bank may agree for a customer to arrange an overdraft facility to take more money out of a bank account than what is in there. Interest is paid on the amount owed and you may have to pay an administration or arrangement fee. The interest rate on an overdraft is typically higher than a personal loan and if you go over the agreed limit charges (e.g. fees and additional interest) can be very high. Mortgage: This is money borrowed to buy a home or other property secured against that property. If you don t keep up the payments on a mortgage the lender may take the property back (through the courts) and sell it to recover their money. As with other loans you pay it back over time with interest, but mortgages are typically paid over long periods (e.g. 5 to 35 years). Hire Purchase: This type of credit is often used to pay for items such as a car or a large household appliance. It is different to other types of credit in that you don t own the item until it is paid for in full (along with any interest charges), rather you hire the item and pay agreed instalments. You cannot sell or dispose of the item without the lenders permission until it is paid in full as it is only yours at this point. You can terminate a hire purchase agreement (in writing) at any time and return the item but

6 may have to pay some additional money if you have not yet paid 50% of the total price. Mail Order Catalogues: Companies selling consumer goods by post like clothes or household items, toys, electrical goods and so on. They allow you to spread the cost of the goods over time in regular payments and sometimes with interest. The interest (if charged) can be quite high on these making them more expensive than those brought in high street shops or on-line. Store Cards: These are operated by a shop or chain of shops that allows you to buy goods on credit at that store (or partner stores) with interest added monthly. The interest charges can be very high and are usually more than credit cards. Doorstep Loans (Home Credit): These are loans provided by financial companies with agents who come to your house to arrange them and collect payments. Payments are usually collected weekly, fortnightly or monthly and usually in cash. These companies are regulated by an organisation called the Financial Conduct Authority (FCA) and this should be on all of their paperwork. If it isn t the company may not be genuine. You should ask to see their lenders licence or other authorisation. There are doorstep lenders who operate without a licence who are illegal and potentially dangerous so should be avoided. Most doorstep lenders make their money by offering loans to people who would not get credit anywhere else and they usually charge very high interest and fees because of this. Doorstep lending can be very expensive and a decision to borrow in this way should not be taken lightly. Always keep a record of repayment, for example a repayment book. Pawnbrokers: These are lenders that will offer you money according to the value of the goods that you bring in to them. You leave the goods with them and get them back once you have repaid the loan and interest. You must get a receipt (ticket) when you leave the goods with them. If you don t pay off the loan within the time period the lender can sell your goods to get their money back. This is a type of credit often offered to people who would not get credit elsewhere and comes with a very high charge. A lot of pawnbrokers also cash cheques before the time they would normally clear but for doing this they will take a fee from the total value of the cheque itself, often quite a lot of it. Ask how much the fee will be before you borrow. Payday Loans: This is intended as a short-term loan borrowed from a company until your next payday. It is usually at a very high interest level and APR and with other charges to get the money to you quickly or because you don t have good credit. These can be very expensive for people and often come with very large penalties if a payment is missed. They are often offered to people who would not get credit somewhere else which is why there are such high charges. They are very accessible in the high street and online. There are certain rules a lender must follow and you can make a complaint if this is not done. Think very carefully before taking out a payday loan as it is very easy for these to roll over from month to month or lender to lender. Be wary of roll over loans as if you cannot repay them the interest can cause the debt to escalate very quickly and can be very difficult to manage.

7 Buy Now, Pay Later: Where you are offered consumer goods without paying any money up front if you agree to pay for the goods by a certain date. Some of these types of credit are often labelled as interest free but this is usually only for a certain amount of time. Once this time has lapsed interest is charged alongside the cost of the goods which is usually very high. You are often asked to pay for buy now, pay later goods in instalments. Credit Unions: Credit Unions are owned by their members and are run for their members. They pool their savings to provide each other with low interest loans. Some will lend money to new members and some will insist that you wait a certain amount of time or have a certain amount lodged with them in order to borrow more money. You usually need savings before you are eligible for a loan. The amount of APR/Interest a Credit Union can charge is capped by law and is often much lower than other forms of lending. Credit Union members usually have to have a common bond, such as working or living in the same area. Tabs, Slates: In some local communities, particularly when people are well known to each other it may be possible to obtain goods like groceries from local shops on the promise that you pay the balance another time. This can very difficult if people don t keep track of this or if more goods are taken than the person can afford to give back. It can also mean you may not be able to get further goods from the business and could damage the local business itself. Loan Sharks: These are people who lend money illegally as they are not registered to lend. There are very strict laws in place covering who can lend money and under what circumstances and loan sharks are not a part of this. They charge extortionate interest and often take illegal action to recover money such as threatening people, harassing people, taking things from people s houses or perhaps even becoming violent. Loan sharks often work by going to people s homes and do not provide much in the way of paperwork to confirm agreements made. They often target desperate and low income families and at first appear friendly. Always ask the total debt that needs to be repaid. It is never a good idea to use such services and if you are approached by such people you should not avail of their services or if you are in such an arrangement you should consider contacting the police. If you owe money to a loan shark you do not have to pay it back as they are illegal. In Northern Ireland you can contact the Trading Standards Consumerline on if you think someone is lending money illegally. Borrowing from Family or Friends: Borrowing from friends or family can be very tempting as no interest is usually paid and it can avoid expensive borrowing options. However, it can impact on relationships and friendships if the money is not paid back or not paid on time. Leaving a loved one out of pocket can be very stressful and harmful.

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9 Comparing/Choosing Credit: Shop Around: When choosing a credit option and deal always spend time shopping around to get a good deal and one that suits your needs and situation. Spend time looking around to see what is on offer from different lenders. You may well be able to get a cheaper deal elsewhere, reducing the amount that you need to borrow, or find one with terms and conditions that better suit your needs. Always remember to read the small print. Price Comparison Websites can be useful to look at different deals. It is worth looking at different comparison sites to get a more comprehensive view of the deals on offer. Tip: If you are comparing lots of deals on a comparison site, check whether this will show up on your credit file. Some lenders will carry out a full credit check on you if you get a quote for a loan. If this happens lots of times it could harm your credit rating. (Source: Money Advice Service) Compare the Following: 1. Annual Percentage Rate (APR) This represents the cost of borrowing, and illustrates how much your credit will cost per year. It will take into account fees and charges over the year including the interest rate. However, some charges, such as early redemption fees or late payment fees are not included in the APR. APR Example 1 2 : For example, if you had a loan with an APR of 7.7%, this would mean that for each year that the loan was outstanding, 7.7% of the amount borrowed would be added to the total amount you would have to repay. Therefore, if you borrowed 1,000 over the period of 1 year at 7.7% APR you would pay back 1,077 ( 1000 x 7.7% = 1077). APR shows how much you will be charged to borrow the money per year: Generally the higher the APR the more expensive the loan. APR will vary between lenders and types of credit. It is best compared across similar types of credit and the same repayment period. APR Example 2: The table below shows an example of how different APR s affect what you would have to repay if you borrowed 1,000 over 10 years (these are examples): 2 Source: Adapted from Money.co.uk available at

10 APR you Will Pay in Total: Credit type Credit Union Loan Bank Loan Credit Card Store Card Pay day loan Door step loan Credit Build Card 3 Borrowing Apr % Loan length Pay per week Pay per month Total interest paid Total amount repaid % 1 year % 1 year % 1 year % 1 year ,214% 30 days % 52 weeks n/a n/a % 1 year Additional Charges: Are there any other charges not included in the APR, such as an administration charge, an arrangement fee (for loans/mortgages), and balance transfer fees (for credit cards)? 3. Fixed or Variable Interest: Will the interest stay the same? If it is variable could you afford the repayments if the interest went up? 4. Length of Loan: How much you pay back on credit depends on how long you pay for: The longer the period the more expensive the loan. However, spreading the loan over a longer period can make it more affordable due to lower instalments even though you will pay more overall. 5. The Amount Borrowed: The more you borrow the more it will cost as interest will be paid on a larger amount of money so consider this when deciding on the amount. 6. Cost per Week or Month: What is the cost of the weekly or monthly instalments and can you afford these? 3 Source: Citizens Advice Bureau

11 7. Total Cost: How much will you pay in total (including interest and any fees)? All loans should tell you how much you pay back overall. By law when you borrow money the lender must tell you the interest rate, the total repayment, and how much you have to pay each week or month. The information should also be on the company s website. The Money Advice Service has an on-line calculator which you can use to work out the true cost of any borrowing, available at: MAS Loan Calculator: MAS Credit Card Calculator: MAS Mortgage Calculator: You will need to look at such things as the repayment period and APR to work out the total cost of borrowing. A loan may have a low APR, for example, but if the borrowing period is long total repayments may be more than on a loan with a higher APR but shorter repayment period. 8. Penalties: Are any penalties charged for missed payments, late payments or paying the loan off early (early redemption fee)? If so what are these? 9. Insurance Cover: If you are offered insurance to cover payments check to see if you are covered elsewhere, if you can find cheaper insurance through another provider and if the deal is right for you. Some policies won t cover certain circumstances, such as those who have a medical condition or are selfemployed. You may be able to find a more inclusive policy elsewhere that better meets your needs. Think about if you really need the insurance, you may decide that you don t need insurance at all. 10. Secured or Unsecured Borrowing: Do you have to secure the loan against an asset and what would be the risks if you cannot keep up repayments (e.g. losing your home)? 11. Other Risks? Not all credit options are safe or good. Some options such as doorstep lenders and payday loans can be very risky and should not be considered lightly. Loan sharks should be avoided. 12. Time to Think: Can you take the credit agreement away to give you time to think about it and look into anything that you don t understand before you have to sign it? Read the terms and conditions of the agreement and be sure to look at the small print. If there is anything that you are not sure of make sure you ask about it and clarify before signing the agreement. NEVER borrow money on the spur of the moment, make sure you research and think about your options.

12 Eligibility & Credit Rating: Depending on your credit rating different levels of interest are available from 0% APR cards right up 976% APR loans. Each time a person applies for credit a search is carried out on their credit rating and this is marked, this can affect a person s credit rating. Martin Lewis Money Saver Website provides a Credit Card eligibility calculator for individuals to use, this enables you to check your percentage chance of being approved for lower rate credit without leaving a mark on your credit file: The site also provides a free up to date score from Experian through their Credit Club, this allows you to keep track of your Credit Rating and also gives tips on how to improve this through simple steps. For more information or to sign up: Other Things to Think About Be careful about borrowing more money to pay off existing debts. Additional borrowing can seem like a good idea and may well help in the short-term, but can too often lead to more serious longer-term problems Be really careful about signing up to interest free deals. They're only interest free if you pay them off within a certain time period. If you don't pay them off within this period, you will pay a very high rate of interest Watch out for the offer of a payment holiday on credit card and loan agreements. This is where you can stop making payments for a short time, but are charged extra interest once you start making them again. What seems like extra money in your pocket is actually a way to make sure you pay more interest to your lender Always try and pay at least 10% of your balance every month on your credit cards. If you only pay the minimum amount, you'll be paying for ever Avoid going overdrawn on your bank account without agreement. You'll be charged much less if you agree the overdraft beforehand Don't borrow from Loan Sharks. If you're finding it difficult to get credit, see if there's a Credit Union in your area instead or see if you can borrow from the Finance Support. 4 4 Source: Adapted from Citizens Advice (UK)

13 Comparing and Choosing Credit - Example The example below is taken from the Money Advice Service and demonstrates the importance of comparing and shopping around for credit. 5 Example John: John needs to borrow 1,000 to replace his car. He gets a quote from the garage for the car, including paying back the cost over two years. However, when he reads the contract he notices that if he takes out their credit for two years he will pay more than 300 in interest. John looks around at other options. As he has a good credit rating, he considers: taking out a credit card with an introductory interest-free period of 15 months on new purchases, or applying for a personal loan with an interest rate of 10% that he can pay back over two years This is how much John may have to repay each month and overall: Option Interest rate Monthly repayment Total amount repayable Credit card over 15 months 0% ,000 Personal loan over two years 10% ,107 ( 1,000 borrowed interest) Garage credit agreement over two years 30% ,342 ( 1,000 borrowed interest) In the end, John takes a look at his monthly budget and decides that he can afford to take out the credit card and pay the extra each month to avoid having to pay any interest. It means he will have paid off the balance in 15 months and he won t have been charged interest. John will only save money because he knows he can make the payments within the 15 months. If you don t think you would be able to do that, a credit card could cost you more. What this table shows is the difference in repayment plans over different periods of time and how being able to pay a little more each month may mean you re able to take out a much cheaper form of credit. It also highlights the importance of shopping around for credit and not just taking the first product you are offered. 5 Source: MAS

14 What is the Best Credit Option for You? 6 Reason for Borrowing Consider Top Tips I only need to borrow for a short time. Credit card: many have interestfree deals for up to three months and some credit cards charge no interest on purchases for over a year. Only if you re sure you can repay the debt within the interest-free period. Cards charge around 17% interest or more once the introductory offer finishes. Know how you ll pay back the amount before the 0% period ends (set up Direct Debit to pay off regular amounts). Do not borrow more than you need. If you ve a poor credit record you may be charged a much higher interest rate - some cards also charge a fee. I want to borrow some money but pay back a fixed amount every month. Personal loan: may be cheaper than a credit card over a longer period. The interest you ll be charged may depend on your credit rating. Small loans for a short periods cost more (sometimes 15% or more). Often there s a minimum loan amount. You must make the monthly payments. Not all personal loans charge a fixed rate so make sure you check. I only want to borrow a small amount of money for a short period. Overdraft: some current accounts offer interest-free overdrafts up to an agreed limit. Other accounts charge fees as well as interest. Only if it s authorised by the bank (otherwise you ll be charged a very high interest rate). Your credit rating could be damaged if you borrow above your limit. Not for longer term borrowing it is very expensive - the bank can ask for repayment or reduce the overdraft limit at any time. I have existing debt I want to pay off as cheaply as possible. Balance transfer credit card: some cards allow you to transfer your debts and pay no interest for up to two years. That means they can be a cheaper option for paying off other debts. Most cards will charge a fee of around 3% if you transfer your balance. Know how you ll pay back the amount before the 0% period ends (set up standing order to pay off regular amounts). You ll only qualify for a balance transfer card if you have an excellent credit rating. I want to deal with my debts as cheaply and simply as possible. Debt consolidation loan: consolidating existing debts into one loan can mean you pay less each month and can help keep track of your debts. You might pay less each month, but loans can last much longer so you d pay back more overall. Don t secure a debt consolidation loan against your home before taking independent financial advice. I want to borrow but my bank won t help. Credit unions: if banks can t help, a credit union could be an option. These not-for-profit organisations usually serve a particular community. Run for and by their members and offer low cost loans (no more than 26.8% APR) and there are no hidden charges or penalties. Only borrow if you can afford the repayments. I m struggling to pay my debts and living costs but I can t get any more credit. Social Fund/Discretionary Support: if you re on a low income and in real trouble, you may be eligible. You need to pay off as much of your debt as quickly as you can to try and bring it under control. Seek help from a Debt Adviser who can help you draw up a budget, deal with your creditors and see if you are entitled to any extra benefits. Help from Advice NI is free, don t pay for advice. Don t use a doorstep lender or payday loan company if at all possible - they can be very expensive. 6 Source: Adapted from MAS (2014)

15 Borrowing On-line Tools The BBC have a useful interest rate calculator at: There are other useful tools at: MAS Loan Calculator: MAS Credit Card Calculator: MAS Mortgage Calculator: Money Saving Expert This site also provides a free up to date score from Experian through their Credit Club, this allows you to keep track of your Credit Rating and also gives tips on how to improve this through simple steps. For more information or to sign up: