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Guide to Types of Credit Available

Introduction

There are times in all our lives when we need cash up-front for something we want to have immediately – even though we don’t have all the money in the bank to pay for it.

In such cases, there are various ways of borrowing that money.

Overdrafts

This is a time-honoured way of getting hold of money quickly and easily. Your bank agrees you can use a sum in excess of what you have in your account, on which you pay a certain amount of interest.

The advantage is that the interest charged applies only to the sum you still owe. So every penny of the debt you pay off means that next month the interest will be lower. You can use an authorised overdraft as a permanent line of credit, paying back as little or as much as you can afford each month.

But overdraft rates can be high, making this an expensive long-term option – and higher still if you move into unauthorised territory, with some banks charging up to 30 per cent and upwards if you take out an overdraft without permission.

In addition, many people are familiar with letters sent out telling us that we have breached our limits – charging us £35 for the privilege.

Bank loans

Here, what you are doing is “regularising” your debt. You borrow a certain amount and agree to pay it back at an agreed rate of interest over a certain number of months or years.

Loans, whether from banks or other specialist lenders, are often much cheaper than overdraft rates, even more so if they are “secured” – that is, tied to your property in the event of default.

But you are tied into making monthly payments, so if you can’t afford to do so you are stuck. If your loan is secured and you are unable to pay it off, you may lose your home. And paying off a loan early can involve hefty redemption penalties of up to two month’s interest.

In addition, the seemingly-cheap cost of loans is subsidised by the “sell-on” of payment protection insurance, which can add up to 30 per cent to the total cost of the sum borrowed.

Loan protection cover is NEVER obligatory from that provider, no matter how hard someone tries to sell it to you. If you need it, much cheaper protection is always available elsewhere, so be prepared to shop around.

Credit cards

These are the seemingly simple solution to all our problems. You agree a certain amount of credit and you can then spend up to that limit each month.

As long as you pay off your debts on time each month, you pay no interest: in fact, you can receive up to 56 days’ interest-free credit. If you make a minimum monthly repayment, usually, five per cent and sometimes less, you can spin out what you owe and make larger lump sum payments when you can afford them.

Moreover, some credit cards offer varieties of 0 per cent finance deals for periods of up to nine months, either on balance transfers or on new purchases too.

The danger here is often one of self-discipline, or lack of it: it is very easy to end up with too many cards, transferring debts from one card to the other and spending beyond your means.

Minimum payments can mean paying off the debt will take far longer than you imagine. One piece of research suggested that making the minimum payment required by some companies could lead to debt taking more than 20 years to be paid off.

Store cards

These are another form of plastic credit, offered by large stores or chains of stores. They can be useful, particularly in cases where they come with an introductory discount on that day’s purchases for new applicants.

But the interest charged is almost always astronomical, more than 30 per cent APR in a few cases.

More pages

Page 1: Introduction
Page 2: Mortgages

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