Eastbourne Citizens Advice Bureau
Financial Literacy
BORROWING
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Borrowing
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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
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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.
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Fact:
In April 2013 the Bank of England
announced that the amount of money
borrowed by UK consumers had reached
1.4 trillion pounds.
That’s:
1.4 million million pounds
In the years 2011-2012 Citizens Advice has
seen a 23% increase in the number of
people seeking help for debt problems
from the previous year
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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 £1000 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 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 e.g. standing order, cash payments,
cheques etc and the date each month when you must pay.
Lets look at some examples:
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You want to borrow £1000 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 give you the following figures:
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These figures are example only
Loan amount: £ 1000.00 Typical APR: 17.8 %
Term: 12 months
Initial repayment: £ 90.91
Subsequent monthly repayments: £ 90.97
Total amount repayable: £ 1091.58
Loan amount: £ 1000.00 Typical APR: 17.8 %
Term: 18 months
Initial repayment: £ 62.93
Subsequent monthly repayments: £ 63.10
Total amount repayable: £ 1135.63
Loan amount: £ 1000.00 Typical APR: 17.8 %
Term: 24 months
Initial repayment: £ 49.18
Subsequent monthly repayments: £ 49.20
Total amount repayable: £ 1180.78
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These figures are example only
Loan amount: £ 1000.00 Typical APR: 17.8 %
Term: 12 months
Initial repayment: £ 90.91
Subsequent monthly repayments: £ 90.97
Total amount repayable: £ 1091.58
Loan amount: £ 1000.00 Typical APR: 17.8 %
Term: 18 months
Initial repayment: £ 62.93
Subsequent monthly repayments: £ 63.10
Total amount repayable: £ 1135.63
Loan amount: £ 1000.00 Typical APR: 17.8 %
Term: 24 months
Initial repayment: £ 49.18
Subsequent monthly repayments: £ 49.20
Total amount repayable: £ 1180.78
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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
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The Annual Percentage Rate of the total charge for credit
(APR) 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 totalled and then
expressed as an annual rate.
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Payment Protection Insurance
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.
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PPI can be very expensive and it may not be suitable for you or
you may have other ways to cover the repayments if you need
to, so stop and think about whether you really need it before
you agree to take it out
Always check the terms and conditions of the policy very
carefully. There will often be lots of exclusions, which means
there may be lots of circumstances where you won't be covered
if you want to make a claim
If you have a loan which includes PPI and you feel you were
mis-sold this product, you may be able to get a refund.
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Payment protection insurance is normally optional but
some credit arrangements make it compulsory.
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% 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.
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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.
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OVERDRAFTS
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.
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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.
Account balance
£600
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.
-£200
-£275
Your wages of £900 go into your account
What does your account balance show now?
Click to show the answer
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?
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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.
Account balance
£600
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.
-£200
-£275
Your wages of £900 go into your account
What does your account balance show now?
Answer = When your wages are paid in, your account
balance is £625 minus any interest charges. Many
student accounts do not charge interest on overdrafts.
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£625
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This is a copy of the terms and
conditions for a typical overdraft for
a current account.
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The interest rate is
shown as 1.36%
per month
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Interest rate 1.36% per month.
Account balance
In our example you were overdrawn by
£275
Your wages of £900 were paid into your
account.
-£275
+£900
£625
Therefore you would be charged £3.74
interest for the first month.
The balance minus interest charges after
one month would be:
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Interest charge
-£3.74
£621.26
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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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The terms and
conditions also
show what happens
if you were to
exceed the agreed
overdraft limit
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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 which shows:
• Each item of spending
• The total balance
• The interest charged
• The minimum amount you can repay this month,
usually 5% of the total balance
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This is a credit card statement from a
high street lender. Most statements are
sent out monthly.
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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
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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 = £1.00
Interest on the balance = £2.42
So: £177.74 minus £50 = £127.74
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plus £3.42 charges this month =
£131.16 left to pay
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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 12th March.
You receive your credit card statement on 20th March and the balance
shows £50. The minimum payment is £5 to reach your account by 2nd April
You pay £50 on the 22nd 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 month how much
would your total balance be next month? Click to see the answer
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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 12th March.
You receive your credit card statement on 20th March and the balance
shows £50. The minimum payment is £5 to reach your account by 2nd April
You pay £50 on the 22nd 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 month how much
would your total balance be next month? Click to see the answer
£45 x 1.36% = £0.61 interest total balance = £45.61
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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?
Click to see the answer
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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?
It would take 10 months to pay off the balance and
you would be charged £3.33 total interest.
Total cost £53.33
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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.
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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. Repayment is made in instalments. 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.
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Interest free credit
This is potentially a good way to purchase goods though it
is not often available. You do not 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 ‘9 months interest free option’ is offered which is
very different from ‘interest free credit’.
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Here is an example of an interest free credit offer from
one high street electrical retailer:
Buy Now Pay Later 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
£1270.23. 29.5% typical APR. Interest calculated from
date of agreement.
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Here is an example from a catalogue retail store:
Typical example. 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.
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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.
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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 discount and
privileges.
A store card generally
• Is considered as another payment method amongst others
such as cash, credit cards etc
• Has a lower credit limit than a credit card, and
• 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.
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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 – 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?
• Check all terms of the agreement - APR, interest free period, penalties for default
and late payment
• If Payment protection Insurance is offered is it worth having? Read the terms and
conditions
• Beware of persistent shop assistants who try to persuade you to sign up for a
card.
• Don’t be rushed into it. If in doubt take the paperwork home and read it before
signing anything.
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Hire purchase (HP)
Under a hire purchase (HP) agreement, you hire goods until you pay the final
instalment. You will not own the goods until then.
This means that you can end the agreement and return the goods at any time.
However, you will owe any overdue instalments and, if less than half of the total
price has been paid, you may also have to pay the difference.
The company which has made the loan (the lender) may be able to take back
(repossess) the goods if, for example, you fall behind with payments. The lender
does not have to sell the repossessed goods to reduce your debt.
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Hire purchase
Advantages
Disadvantages
Allows you to buy more
You do not own the
expensive items on credit goods until you have paid
off the full amount.
It may be easier to get a
Hire Purchase agreement The Hire Purchase
than a bank loan or credit company can take back
card
the goods if you do not
keep up with payments.
Conclusion
You can return the goods
and end the agreement
any time as long as you
are up to date with your
payments.
Its worth considering
other forms of credit first.
If the goods are taken
back you may still owe
money on them.
HP can be more
expensive than a loan or
a credit card.
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Mail order
Mail order shopping is usually arranged through a catalogue and is
normally interest free, the customer paying only the price of the
purchase in instalments. However, goods bought in this way may
be more expensive.
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Mail Order catalogue goods on credit
Advantages
Disadvantages
Conclusion
Small weekly
repayments
Catalogues may be
more expensive
Compare with prices in
shops before buying,
It might be easier to get
catalogue credit than
from other lenders
Can be higher interest
rates
Compare interest rates
with other forms of
borrowing before buying.
Only borrow the price of
goods you buy
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Doorstep sellers
Selling or promoting goods or services on credit by calling at people’s
homes is illegal unless the company has a licence to sell credit outside trade
premises. Common examples are double glazing or home improvements.
Any agreement that is made illegally may not be enforceable.
It is a criminal offence to try to make a cash loan outside trade premises
unless the visit is made to your home in response to a written and signed
request. Any agreement that is made illegally may not be enforceable.
If you have signed an agreement of this type seek advice.
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Credit unions
A credit union is a self-help co-operative whose members pool their
savings to provide each other with credit at a low interest rate. If a
member fails to repay a loan, the credit union can seek repayment
through the courts.
Credit unions encourage people to save what they can and only borrow
as much as they can afford. After you have been saving with the credit
union for a few months you can apply for a loan.
The maximum interest charge is 2% per month.
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Pawnbrokers
Pawnbrokers lend money against the value of property left with them.
They must give a receipt known as a ticket. Pawnbrokers agree to keep
the property for at least six months but you can get it back at any time
during that period by paying off the loan plus interest. The period can
be extended by paying the interest only and re-pledging the property.
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Loan sharks
lend money to people who are usually unable to borrow from other
sources. They charge very high interest and are not concerned by
your ability to repay. They may force you to take out a second loan
to repay the first.
If you get behind with payments a loan shark may threaten you.
This is illegal and you
If you have entered into an agreement with a loan shark or an
agreement with excessively high interest you should seek advice.
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Payday Loans
Payday loans are short-term loans for small amounts of money.
They are available from high street shops and internet sites.
Payday loans can be easy to get but interest rates are very high.
There may be other ways for you to sort out your short-term money
problem so think about the alternatives before you borrow.
If you are having problems paying back the loan the lender may
offer you longer to pay. This is known as a loan extension or
deferral. Beware of doing this. If you extend the loan you will have
to pay more interest and there may be extra fees.
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Consolidation Loans
A consolidation loan is a loan to pay off all your existing debts from
whatever source such as credit cards, loans, overdrafts etc.
From then on you only make repayments to the new creditor. The
advantage of this is only one payment to remember.
The disadvantages can be higher interest rates and consequences
if you do not make payments on time.
Consolidation loans are usually secured against your home and
therefore are only available to home owners. If you fail to keep up
the payments you could lose your home.
You should think carefully before taking out a consolidation loan.
There may be better, cheaper ways to pay off your existing debts.
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Mortgages
If you wish to buy a home you may be able to borrow money to do
this. This is called a mortgage. The loan is for a fixed period usually 25
years and you have to pay interest on the loan. If you do not keep up the
agreed repayments, the lender can take possession of your home.
Mortgages are available from banks and building societies and also other
lenders. This is a very competitive area and the lenders are constantly
changing the types of mortgage they offer. Because of this it is not possible
to cover this subject in detail here.
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There are several types of mortgage available. The most common are:There are two main types of mortgage:
repayment mortgage, where your regular repayment goes towards the amount
you borrowed (the capital) and the interest so that the whole loan is paid off by
the end of the mortgage
interest only mortgage, where your regular repayment goes towards the
interest only. At the end of the mortgage you repay the capital in a lump sum.
Usually this will be from savings or an insurance policy you took out at the
same time as the mortgage. For example, an endowment or pension.
Islamic mortgage. This is a mortgage in which none of the monthly payments
includes interest. Instead, the lender makes a charge for lending you the
capital to buy your property which can be recovered in one of a number of
different ways, for example, by charging you rent.
The cost of the mortgage depends on the interest rate. There are lots of different
types of interest rates such as fixed rate or variable rate. It's worth taking some time
to compare types and decide what suits you best.
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Before borrowing money you should consider the full cost of
paying it back and how this will affect your budget. Can you
afford the repayments over a period of time?
You should compare interest rates and opt for the lowest.
Borrowing money can mean you can buy things now rather than
having to wait to save up the same amount of money. Do you
really need to buy it sooner rather than later?
With so many people getting into problems as a result of
borrowing money do you want to be another part of this growing
statistic?
Do you know what the consequences can be of borrowing
money and getting into debt?
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People get into debt for a variety of reasons and it is
not always their fault. Sometimes wreckless spending
or bad budgeting is the cause of debt. Sometimes its
just bad luck and unexpected change of circumstances.
Debt is something that can affect anyone at anytime.
If you find you are having trouble meeting your
payments don’t panic and don’t ignore the problem.
Get to grips with your finances, review your budget and
take action before it gets out of control.
Contact lenders and tell them about the problem.
If in doubt seek advice.
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