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Risk Warnings

Credit cards and loans


There are many different ways to borrow money. You need to understand the different options available to you, and how they work, to decide which one suits your personal circumstances.

When taking out any sort of loan the first thing to understand is the amount of interest you will be paying as this shows you the real cost of the loan and it is the best way to compare deals. With so many options available, you do not want to be paying more than you have to. You also need to be aware of any conditions of borrowing. For example, some loans stop you paying it off early with a lump sum (thereby saving you further interest payments) even if you have the cash to do so. You also need to be clear about what the penalties are if you fail to keep up the repayments.

The most important thing is to make sure you will continue to be able to afford your repayments (make sure you consider all your monthly expenses when you are working out what this amount is).

One of the unattractive truths about getting a loan is the worse your credit history the more unfavourable the deals you will be offered will be. It is therefore important to build up a good credit history, by keeping up with all your repayments, to ensure you will be offered the best deals in the future.

What it means for you

What follows is a breakdown of the main ways to borrow money or get credit, and the pros and cons of each:

Current account overdraft

Having a current account overdraft can be a flexible way of borrowing money short term. However, overdrafts which include a fee on top of interest can make them an expensive way to borrow.

Pros - They can be easy to arrange, usually costing nothing when you are not using the facility and some banks offer low interest rates. They can be flexible as long as you stay within your overdraft limit. You can repay it as soon as you like without any penalties. Some banks offer a small interest-free overdraft facility on their current accounts.

Cons - Can be expensive. Some banks charge high interest rates, monthly overdraft fees, and even arrangement fees, plus extra charges if you exceed your limit. Overdrafts have a habit of becoming permanent, even when you intend to use one to tide you over for a short period.

Credit card

A handy form of free short-term credit if you pay your bill in full each month. If you are careful to control your spending they can be a cheap way to borrow money to buy things immediately that you want to pay for later.

Pros - Short-term borrowing costs nothing - as long as you pay the whole bill within the interest-free period. You can also take advantage of low introductory rate over, say, six months. They are flexible, allowing you to repay your debt when you like, they can be used for large purchases (subject to your credit limit) and can offer extra protection against faulty goods or non-delivery.

Cons - Credit cards can be a very expensive way to borrow. Another disadvantage is it is easy to build up large debts by spending more than you can afford. You also add to your debt, with extra interest charges, every time you fail to make a repayment, and can pay additional charges for exceeding your credit limit. Remember to check the time limit of any introductory-period offer and for any extra conditions such as an 'exit' fee for switching to another card once the offer period ends.

Some lenders offer 'optional' payment protection insurance which can be a good thing if you fall ill or lose your job, but might not be much use in your circumstances and is often expensive. Remember, you may already be covered by other insurance.

Unsecured personal loan

Personal loans can be a sensible way to borrow a substantial sum over a term of between, say, one and five years. But they can be expensive, and are not so good when you need flexibility or a short-term credit facility. Watch out for lenders trying to persuade you to add to your loan half-way through.

Pros - You have a fixed repayment schedule - so your debt will be paid off within a set time, as long as you meet the payments. Set repayments are handy if you don not trust yourself to repay money you borrow with an overdraft or credit card. Some lenders offer competitive interest rates. It may be more suited to borrowing larger sums, over a longer term, than overdrafts or credit cards.

Cons - Check the terms carefully if you might want to repay early. Many lenders charge you most of the interest you would have paid if you had kept the loan for the full term. These types of loans can be inflexible with set repayments every month, whatever your circumstances.

The cheapest rates may be restricted to the most creditworthy customers or those borrowing larger sums. Shop around to get the best rates. Some lenders offer 'optional' payment protection insurance which can be a good thing if you fall ill or lose your job, but might not be much use in your circumstances and is often expensive. Remember, you may already be covered by other insurance.

Store cards

Some store cards charge a very high rate of interest, sometimes around twice the rate of other types of credit. It may be best not to use them unless you are sure you will clear your bill in full every month.

Pros - May entitle you to special offers at your favourite shop, and if you pay your bill off in full each month, they should not cost you anything.

Cons - Interest rates are usually very high.

Carrying around a purse or wallet full of credit and store cards can be a temptation to spend more than you can really afford. Some 'budget account' cards require you to pay in every month. If you do not buy anything, you just build up a balance. Some lenders offer 'optional' payment protection insurance which can be a good thing if you fall ill or lose your job, but might not be much use in your circumstances and is often expensive. Remember, you may already be covered by other insurance.

Hire purchase

You can back out of the deal and return the goods at any time, but you then have to pay enough to bring your total payments up to half the price of the goods. If the instalments you have paid already amount to that, you only have to pay for any missed payments or damage to the goods.

Look at other options first and if you can borrow the money at a similar or cheaper cost through a bank loan or credit card, steer clear of hire purchase (HP).

Pros - Allows you to buy big-ticket items (a car, for example) on credit. You might find this useful if you cannot borrow enough to fund your purchase through a bank loan or credit card. You might find it easier to get credit from an HP company than from, say, a high street bank or credit card company.

Cons - You do not own the item you have bought until you have paid back all the money you owe, so the HP company can reclaim the goods if you do not make your payments. If you have paid a third or more of the value of the goods, the HP company would have to get a court order to get them back. You may still owe money on goods that have been taken back.

May well be a more expensive way to borrow than a good value loan or credit card. Some deals have smaller payments and a big payment at the end. Make sure you will be able to cover the final payment.

Secured loan or further advance on your mortgage

Beware of putting all your unsecured debts into a long-term secured loan. Do not use the reduced payments as a green light to build up even more debts on your credit card, personal loan or overdraft. If you do want to use the equity in your home to borrow, a further advance from your mortgage lender will probably be cheaper than other secured loans.

Pros - Can be a sensible way to borrow for certain expensive items, such as home improvements. Because the loan is secured against your home, the interest rate should be cheaper than an unsecured loan and you may be able to borrow more. Also, you can cut your monthly payments by stretching the loan over a longer term.

Cons - The consequences of not keeping up your payments are much more serious than with an unsecured loan. If you do not keep up the repayments of a mortgage or any other loan secured on your home you could end up losing it.

Putting all your debts together and spreading them out over a longer term usually means you pay more interest in the long run and being in debt can seem permanent. Not all secured borrowing is cheap - some lenders charge high rates that are more in line with what you would expect to pay for an unsecured loan. Work out how much you have to pay back overall.

Interest free credit deals on goods

Great if you can pay in full at the end of the interest-free period. It is up to you to remember to pay on time. If you do not, you will probably pay high interest charges.

Do not buy items you do not need or poor value goods just because they come with interest-free credit.

Pros - Deals often described as 'interest-free options' allow you to delay paying for an item, perhaps for several months, or even longer. A great source of free credit as long as you are sure you will be able to pay in full by the end of a set period.

Cons - Be careful, they are not really 'interest-free' at all. They allow you the option of avoiding the interest charges by paying up early. But if you go beyond the period, interest will have been charged throughout.

Some retailers offering interest-free credit rely on the likelihood that you will not be able to pay the full purchase price at the end of the interest-free period. Many people end up paying for an item in instalments, at an interest rate which is likely to be much higher than you could get from other types of borrowing.