Borrowing

Types of borrowing
Who do I borrow money from?
Fact
Loans
Borrowing example 1
Borrowing example 2
Annual percentage rate (APR)
Payment protection insurance 1
Payment protection insurance 2
Overdrafts
Overdraft example 1
Terms and conditions for an overdraft
Overdraft example 2
Overdraft example 3
Charges for exceeding an overdraft limit
Credit cards
Credit card statement 1
Credit card statement 2
Credit card statement 3
Paying off the current balance
Current balance example
Charge cards
Credit agreements
Interest free credit
Interest free credit offer
Example from a catalogue retail store
Store cards
Store cards – tips
Card comparison
Hire purchase (HP)
Hire purchase: advantages and disadvantages
Mail order
Mail order: advantages and disadvantages
Doorstep sellers
Credit unions
Pawnbrokers
Loan sharks
Consolidation loans
Mortgages
Consequences of borrowing
Getting into debt

[1]

Borrowing

[2]

Types of borrowing

Many of us will need to borrow money sometimes and there are several ways to do this. Some ways cost a lot more than others.

In this unit we will look at how borrowing money works in various forms including:

• loans
• overdrafts
• credit cards
• credit agreements
• interest free credit
• store cards
• hire purchase
• consolidation loans
• mortgages.

[3]

Who do I borrow money from?

You could borrow money from a friend or family member, in which case the arrangements for paying the money back are entirely up to you.

Although friends and family are less likely to charge you interest and will probably be more flexible with repayment, borrowing money from people close to you can sometimes put a strain on your relationship.

In comparison, borrowing from a bank or building society is a business transaction with clearly defined rules to follow.

[4]

Fact

In November 2004 the Bank of England announced that the amount of money borrowed by UK consumers had reached £1 trillion.

That’s: one million million pounds.

Citizens Advice has seen a 44 per cent increase in the number of people seeking help for debt problems over the past six years.

[5]

Loans

When you borrow money from a bank or other lender you enter into a contract with them which governs the repayment.

You have to be 18 years old to be able to enter into such a contract.

Say, for example you arrange to borrow £500 from a bank:

• the bank will offer you a period of time over which you can repay the money usually stated in months, eg 12, 18, 24 months etc
• the bank will tell you what their interest rate is, stated as an annual percentage rate or APR
• they will tell you how much interest is charged per month and how much your monthly repayments will be
• they should also total these figures up so you can see how much you are paying in total.

You will also agree the means of payment, eg standing order, cash payments, cheques etc and the date each month when you must pay.

Let’s look at some examples.

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Borrowing example 1

You want to borrow £1,000 as a loan and you compare the price of repayments over 12 months, 18 months and 24 months.

The interest rate is 17.8% APR
The bank gives you the following figures:

[7]

Borrowing example

As you can see from these figures, although the monthly repayments are lower, you end up paying more to borrow the same amount of money over a longer period of time.

These figures are examples only.

Loan amount: £1,000 typical APR: 17.8%
Term: 12 months
Initial repayment: £90.91
Subsequent monthly repayments: £90.97
Total amount repayable: £1,091.58

Loan amount: £1,000 typical APR: 17.8%
Term: 18 months
Initial repayment: £62.93
Subsequent monthly repayments: £63.10
Total amount repayable: £1,135.63

Loan amount: £1,000 typical APR: 17.8%
Term: 24 months
Initial repayment: £49.18
Subsequent monthly repayments: £49.20
Total amount repayable: £1,180.78

[8]

Annual percentage rate (APR)

The annual percentage rate (APR) of the total charge for credit is a standard way of measuring the real cost of credit to the customer, expressed as an annual rate.

The APR is different to a flat rate of interest and more accurately reflects the true cost.

The formula for calculating the APR is very complex, but basically the interest and all other charges made for granting the credit (the total charge for credit) are totaled and then expressed as an annual rate.

[9]

Payment protection insurance 1

When you borrow money most lenders will offer you a form of payment protection insurance.

• This gives you protection in case you are suddenly unable to pay, for example due to ill health, an accident or loss of a job.

• It can cover car finance, personal loans, credit cards and store cards, catalogue debts and mortgages.

• An amount for insurance is added to your monthly repayment.

• Payment protection insurance is normally optional but some credit arrangements make it compulsory.

[10]

Payment protection insurance 2

• Most payment protection insurance agreements pay only a part of the balance each month, for a limited period.

• The most common amount paid is 10 per cent for ten months.

• The amount paid off is always equal to or more than the minimum monthly payment required by the credit card or store card company.

• If you are sick, lose your job and become unable to make your monthly payments and you have payment protection cover you should contact the lender and make a claim as soon as possible.

• Check the details of your credit agreement for further information.

• It has recently been discovered that many customers were mis-sold payment protection insurance by their banks. As a result the banks have been forced to pay back millions of pounds in compensation. It is advised that when borrowing money you look closely at the terms and conditions, particularly regarding PPI.

[11]

Overdrafts

An overdraft is an agreement with your bank to take out more money from your current account than it currently contains.

For example, if you have an overdraft limit of £200 on your account you can spend all the money you have in the account plus another £200.

An overdraft can be a good way to borrow money short-term or to have some funds available to cover emergencies.

[12]

Overdraft example 1

For example: you need £800 to put a deposit on a flat. At present you only have £600 in your account and your pay goes into your bank account in two weeks time.

• You arrange an overdraft of £300 with your bank.

• You write a cheque for £800 for the deposit.

• When the cheque is cashed your account shows a balance of -£200. This gives you up to £100 to live on until your wages go into your account.

• You spend an extra £75.

• Your wages of £900 go into your account.

• What does your account balance show now?

Account balance
£600
£200
-£275
£625

[13]

Answer

When your wages are paid in, your account balance is £625 minus any interest charges. Many student accounts don’t charge interest on overdrafts.

[14]

Terms and conditions for an overdraft

This is a copy of the terms and conditions for a typical overdraft for a current account.

[15]

The interest rate is shown as 1.36% per month.

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Overdraft example 2

Interest rate 1.36% per month.

• In our example you were overdrawn by £275.

• Your wages of £900 were paid into your account.

• Therefore you would be charged £3.74 interest for the first month.

• The balance minus interest charges after one month would be:

Account balance
- £275
+£900
£625

Interest charge
- £3.74

£621.26

[17]

Overdraft example 3

How much would the charges be if you remained overdrawn by £275 for 6 months?

Answer

£275 x 1.36% = £3.74 x 6 = £22.44

assuming no other transactions were made on this account.

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Charges for exceeding an overdraft limit

The terms and conditions also show what happens if you were to exceed the agreed overdraft limit.

[19]

Student Loans 1

Student loans are a simple way to pay for university fees, living costs and any equipment you might need for the course, such as books.

It is provided by the Government and through the Student Loans Company.

A student loan differs from a normal loan in many ways. Firstly, if you are using the loan to pay for tuition fees, it will go directly to the university, rather than you having to deal with it. Secondly, the interest rates are much lower than other loans. Thirdly, students are given much longer to pay back their loans. For most cases loans will not have to be paid back until you are earning more than £21,000 (as of 1st September 2012).

[20]

Student Loans 1

All students are eligible for tuition loans and maintenance loans. The tuition loan amount depends on the type of course and the university. The maintenance loan amount is dependent upon where you are studying. Some students may also be eligible for maintenance grants; however these are dependent on the annual family income.

If things get really tough, money wise, there are other options.

There is the National Scholarship Programme that helps students with family income of less than £25,000.

Also some Universities have their own bursaries or funds that can be applied for.

To apply for student loans, visit either Directgov or the Student Loan Company.

[21]

Credit cards

Credit cards give you a separate account from which you can borrow money.

You can use the card to pay for goods or services in shops, by phone or via the internet.

When you first obtain a credit card you will have a credit limit. This is the amount of money you can borrow.

Each month you will be sent a statement that shows:

• each item of spending
• the total balance
• the interest charged
• the minimum amount you can repay this month, usually 5 per cent of the total balance.

[22]

Credit card statement 1

This is a credit card statement from a high street lender. Most statements are sent out monthly.

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Credit card statement 2

Here you can see:

• the amount left over from the previous month
• the amount paid since the last statement
• the amount spent with the card since the last statement
• the current balance
• the minimum payment due.

Please note the small print.

[24]

Credit card statement 3

A second sheet shows the transactions and charges on the account since the last statement.

Here you can see:

• the balance from the previous statement = £177.74
• the amount paid into the account since the last statement = £50
• payment protection insurance = £1
• interest on the balance = £2.42.

So: £177.74 - £50 = £127.74 + £3.42 charges this month = £131.16 left to pay

[25]

Paying off the current balance

If you pay off the current balance within one month you pay no interest on what you borrow. This way using a credit card to pay for things can become a handy alternative to using cash.

For example:

• your current balance is zero
• you buy a jacket for £50 on 12 March
• you receive your credit card statement on 20 March and the balance shows £50
• the minimum payment is £5 to reach your account by 2 April
• you pay £50 on the 22 March
• no interest charge
• balance now zero.

If you paid only the minimum amount of £5 you would incur interest charges on the remaining £45. If the interest rate is 1.36% (per cent) per month how much would your total balance be next month?

[26]

Answer

£45 x 1.36% = £0.61 interest. Total balance = £45.61

[27]

Current balance example

In this example if you continued to pay only the minimum amount of £5 each month how long would it take to pay for the jacket priced £50?

[28]

Answer

It would take 10 months to pay off the balance and you would be charged £3.33 total interest.

Total cost £53.33

[29]

Charge cards

The difference between a charge card and a credit card is that the amount borrowed on a charge card must be repaid in full at the end of a given period, usually a month.

Interest is not charged on the amount but you may have to pay an annual fee for the card.

American Express and Diners Club are the two major operators.

[30]

Credit agreements

• Under credit sale, you buy the goods at the cash price.

• You usually have to pay interest but some lenders offer interest free credit.

• Repayments are made in installments.

• You are the legal owner of the goods as soon as the contract is made and the goods cannot be returned if you change your mind.

• The supplier cannot repossess the goods if you fall behind in repayments, but can take court action to recover the money owed if you don’t keep up the repayments.

• Credit sale agreements are now more common than hire purchase agreements and it is important not to confuse the two.

[31]

Interest free credit

This is potentially a good way to purchase goods though it is not often available.

You don’t pay any more than the cash price but have a period of time to pay for what you’ve bought.

Read the small print carefully. Sometimes a way of paying called ‘nine months interest free option’ is offered which is very different from ‘interest free credit’.

[32]

Interest free credit offer

Here is an example of an interest free credit offer from one high street electrical retailer:

Buy Now Pay 2006 on everything over £299

Cash price £699.99. No deposit required. Either pay £699.99 within 10 months of the date of purchase, total amount payable £699.99, no interest charges paid.

Or 39 monthly payments of £32.57 commencing 10 months after the purchase date. Total amount payable £1,270.23.

29.5% typical APR. Interest calculated from date of agreement.

[33]

Example from a catalogue retail store

Here is an example from a catalogue retail store:

Spend £195 on a 6 month Buy Now Pay Later agreement on your Store Card. Pay nothing for 6 months (although you can if you wish) and then settle the cash price at that point.

Total payable £195.

Or choose to spread the cost over a longer period, paying a minimum 3% or £2 each month (whichever is the greater) and if you only ever pay the minimum the total payable would be £524.36 (25.9% APR).

Includes deferred interest from the Buy Now Pay Later period.

[34]

As you can see from these examples interest free credit can be a good deal if you pay the full amount after the free period.

If you don’t pay the full amount in time you could end up paying more than twice as much for the item.

[35]

Store cards

Store cards are the cards that many major retailers offer their customers as a convenient way of buying goods in their stores, often with incentives attached such as special discounts and privileges.

A store card generally:

• is considered as another payment method amongst others such as cash, credit cards
• has a lower credit limit than a credit card
• can be used only at the issuing retailer store.

Store cards operate similarly to a credit card with a monthly statement being sent to all customers with the requirement to pay off at least the minimum payment.

When considering a store card, you need to weigh up the costs and benefits in the same way as you would for other forms of credit.

[36]

Store cards – tips

Before signing up for a store card consider the following:

• Do you really need a store card?

• Do you have other ways to get credit such as credit cards or an overdraft? If so which has the lowest interest rate?

• Discounts sound tempting but only if you pay off the full balance.

• Is there is an interest-free period? If so how much will the interest be when it ends?