You want some money to borrow but you don’t know how. It is confusing. We’re often asked how to borrow money and what is the best way to borrow money. This is why we’ve put together this guide showing you how to work out what is the best way to borrow money.
Borrowing is an important part of life and a key part of being in business. Actually, the word ‘borrow’ can be a bit misleading because we actually ‘buy’ the money we ‘borrow’ – or rather we ‘rent’ it.
Confused? Well it goes like this…
1. You get a sum of money from a lender who then wants it paid back over a period of time, just as long as you pay back a bit more than you borrowed – sometimes quite a lot more than a ‘bit’.
2. This extra bit is called interest and it’s basically how they charge you for the joy and thrill of having their money for a while.
3. The extra amount you pay (the interest) depends on how much money you borrow and how long it takes you for you to pay it back.
4. The longer you take to pay it back, the more money you end up paying overall.
5. The higher the interest rate (usually shown as an APR, or Annual Percentage Rate) the more money you end up paying overall. This is why we keep saying that the quicker you pay any debt off, the cheaper it is. That goes for mortgages too.
Ways to borrow money
Overdraft facilities – this is when the bank lets you take out more money than you actually have in your account. Most accounts give you a free overdraft facility up to a point, although you still have to pay interest on any money you owe on it. If you go over that agreed amount, though, you will get charged for it and the interest you are charged will be even higher.
Credit cards – when you pay for things with credit cards you don’t get charged interest if you pay within a certain time. If you don’t pay on time, though, you get charged for the extra days you’ve been lent the money. Over time this extra gets compounded and very quickly it can get out of hand.
Personal loans – where you are given a lump of money and you have to pay it back bit by bit each month, with a bit extra on top for the interest until it’s all paid back. These can be unsecured or secured against things you own, like your house. Secured loans are not for everyone.
Hire purchase (HP) – this is a common way to pay for expensive items such as cars or furniture and means you can pay little sums of money each month (with fees and charges added on) until you finally own the product, once you’ve paid off all the instafinlments. Unlike loans or credit cards, you are only hiring the products until these payments have finished – so if you don’t keep up repayments, the lender can take back the goods.
Interest free credit – this can spare you having to shell out a sizeable chunk of change initially and can be paid over a period of time, or paid off as a lump sum at the end of a set time frame. Usually you don’t have to pay anything initially – maybe six months or a year – and then you have to start dishing out the cash to the shop and lots of companies charge hefty fees if you do not pay it off.
Extension on your mortgage – this is an agreement between a lender and a borrower who is struggling to meet their monthly payments. The lender extends the term of the home loan so that the monthly payments are reduced, but overall, you will end up paying more interest over a longer period of time.
Online pawnbrokers: A pawnbroker is rarely a good first option if you need to raise cash but they’re generally better than payday loans companies. With a host of online pawnbrokers such as 62days.com cropping up which offer lower interest rates and no penalties for early repayment, this may be worth considering for a quick fix. Pawnbrokers work by lending you a percentage of the value of a particular item (often jewellery) for a specific period, during which the loan accrues interest and once the term is up you can repay the loan, plus interest and get your item back. The loan is secured against the item you hand over so if you don’t repay the loan, they keep that item. 62days.com offers an even better deal because it will let you sell an item to them, albeit for less than you could get for it in say a jewellers or eBay, but then you have the option of buying it back within 62 days for exactly the same price.
How to get the best loan rates
Improve your credit record: Before you apply for any loan, it will pay to check your credit rating first as many of the top deals will only be for those with a near perfect record. Don’t panic if yours is rubbish, there are lots of ways to improve your credit rating and you can get a free credit check from Experian to start resolving any issues which will improve your score.
Compare interest rates: The most important thing to look at with any type of product that’s offering to loan you money (including credit and store cards) is the interest rate. Use comparison tables to find the lowest rate and remember that headline rates are often only applicable to two thirds of applicants so if you’re credit rating isn’t good, you may be offered a higher APR or refused credit altogether.
Consider alternatives: You may be able to save money by looking at less traditional lenders. One recent development is the growth of what’s called ‘social lending’. Lending websites such as Zopa and Funding Circle now offer an alternative to the banks by bringing savers and borrowers together. So, you borrow money from your peers, instead of the banks, and they in return earn interest from these loans rather than sticking their money into the banks’ savings accounts. Credit unions are another alternative to banks and can often offer members cheaper loans so make sure you investigate these too.
Look for flexibility: Whichever lending route you choose, always try to get a deal that is flexible – that’s where you could pay it off at any time and not be fined for it.
Check the loan period: Borrow for the least amount of time possible because the longer you take to pay off a debt the more expensive it will be. For example, if you borrow £5,000 at 5% interest (APR) and take five years to pay it off, you will end up paying back £5,661.37 altogether. If you take ten years to pay it back, you will have to pay £6,363.93 altogether. It may seem just like numbers, but imagine…would you walk past the difference – £702.56 – if it were lying on the street. Smart people hold onto every penny.
Do your sums: Don’t worry so much about how much the debt will cost you each month. You need to know the TAR (Total Amount Repayable) – that’s how much the debt will cost you to pay off altogether. So, if you look at the example above, borrowing £5,000 for five years means you have to pay it back at £94.36 per month. If you borrow it over ten years you will only pay £53.03 a month. Even though it looks cheaper each month, the total amount you will pay back is more than £700 more than the five-year deal.
Beware of extras: Don’t be pushed into taking out other products sold alongside your loan. The PPI (Payment Protection Insurance) scandal shows how dangerous this can be. These policies were far too expensive and pointless for nearly everyone as they had lots of sneaky caveats in the small print.
Check the T’s and C’s: Make sure you understand the rules whenever you borrow money and if you’re unsure of what things mean, ask the lender and search for information here on Moneymagpie. For example, with some 0% finance deals on offer in shops, if you are late with any payments, or you miss one month, they insist on all the rest of the money to be paid now (as well as slapping on all the interest you would have paid during the 0% period).
Which form of borrowing is best for you?
To help you make the right decision, we explore various scenarios to highlight how different circumstances call for a different point of action:
You have excellent credit history and you want to borrow money for a big one-off purchase, with the least risk to yourself
Lenders are pretty fussy about who they will lend to, but if you have a blemish-free credit record, you can expect to be accepted on the best buys.
Generally, when you’re borrowing for a specific purchase such as a car an unsecured personal loan is the most viable option. These are set at a fixed rate so you know what you’ll be paying each month from the word go and you don’t have to worry about the rate changing. Check out the cheapest loans here and then see how they compare to the rates offered by social lending websites such as Zopa.
You have a good credit rating and need a short term loan
A credit card may work out cheaper for purchases and you could borrow money for free as long as you clear your bills in full each month.
If you need to borrow money for longer than 30 days, pick a card with the longest interest-free period for new spending – see the best buys here – so that you can avoid paying any interest for a set period of time.
However, credit cards shouldn’t be used to borrow as and when you feel like it. Make sure you borrow the least amount possible, make at least the minimum repayments each month and clear the debt before the 0% period ends to avoid getting into trouble. Watch out for nasty charges, for example, using your card to withdraw cash and you could be hit with an instant fee plus sky high interest the minute that money is in your hand.
You have a really poor credit rating and you want to borrow a small amount of money for a short time
If you can’t access the top credit cards, look to alternatives such as credit unions. These offer members the chance to save their money for a decent and reliable return, with that money being lent out to other members at an affordable rate. This isn’t a quick fix as you will need to be an established member of a credit union and have already set up a savings account before you can get a loan, but it is a fantastic option if you’re struggling with the banks. Find one near you on the FindYourCreditUnion website.
Whatever you decide, don’t be tempted into payday loans – we show you how dangerous they can be here. We’re not fans of pawnbroking here at Moneymagpie but if you’re desperate, a pawnbroker is usually better than a payday loan company. Websites such as Borro.com don’t carry out a credit check because the loan they will offer you is secured (they have the security of your valuable item, and will sell it if you don’t pay off the loan) but you must be absolutely clear about the interest rate and watch out for any penalties.
You have only a few blips on your credit record and you want the cheapest form of loan
If you have a decent enough credit record with plenty of equity in your home a secured loan can be a good option.
Secured loans are usually cheaper in terms of monthly payments and easier to get than unsecured loans because the loans are ‘secure’ for the lenders and they are more willing to lend to those with imperfect credit scores.
You can borrow much more with a secured loan – up to £100,000 in comparison to the £25,000 maximum on unsecured loans – and for a longer period which is why you can be pay smaller monthly repayments. This does mean you’ll end up paying more in interest, however, so don’t take this decision without careful consideration of the alternatives. Read our guide to secure loans for more help.
You have a decent credit rating and want to borrow small amounts to cover a short-term cash flow problem
Despite all the controversy about bank overdraft charges, if you’re careful, you can sometimes borrow money cheaply on an agreed overdraft with your bank account.
Overdrafts are more flexible than loans because you pay them back when you can. They can also be extremely cheap if you’re credit rating is good enough and the bank is willing to offer you a cheap overdraft. For example some accounts offer deals such as a 12 month 0% overdraft (although you usually need to switch over all your direct debits and pay in a set amount per month).
However, this is not a good option if you need to borrow a large amount over a long term because the interest rate is typically higher once any interest free period is over. Also, if you go over the agreed overdraft limit, your bank could hit you with some hefty charges.
You have existing credit card debt and you want to make it cheaper
In this case, a personal loan is unlikely to be the cheapest option and you should look instead for a credit card balance transfer deal instead. These are cards available which allow you to move across debt from other cards and pay them at a cheap rate. Some offer several months at 0% (read about them here) which may work well if you can pay back the debt within the interest-free period.
Otherwise, a long term low rate is your best bet because you can put the card to one side and pay it off at a cheap rate until it has been cleared. The best of these cards offer one rate for the lifetime of the balance but rates will vary depending on how long you think it will take to repay. Check out the best buys in this article or compare other cards here.