How to Borrow Wisely

While borrowing potentially leads to a mountain of debt and eventually, misery, credit – when used right, can be a powerful tool as well.

The UK is a country of borrowers. According to Credit Action, the total personal debt in the country amounted to £1,460 billion back in March 2010. This translates to about an average of £30,258 per person.

Whilst some types of credit are bad and can foil your financial dreams, where you end up paying more than you borrowed, credit can still be a useful tool when it comes to financial planning – when used in a smart way.

If an individual pays his or her balance in full every month, then there should be no interest added to the bill. However, many fall into the trap of just paying the minimum every month – amounting to around 3% of the total outstanding balance. This is very costly, as an example, a person who has a £2,000 credit card debt with an interest rate of 12.9%, and is making minimum payments at 3% of the total would take about 167 months – almost 14 years, to finally pay up, not to mention an additional £1,016 in interest.

As repaying in full every month is not an option for everyone, consider 0% balance transfer cards. These cards allow the transfer of outstanding balances for a free – usually 3% of the balance being transferred. The initial payment will make up for about 15 months without interest being added up to your current debt.

Although it is important to look out for payment hierarchy, as many credit card companies use your repayments to pay off those balances that have the lowest interest rates – leaving your high-interest accounts still running and accumulating.

If you would like to borrow for a longer period of time or for a bigger amount, then a personal loan would be the better and cheaper option. This is especially applicable if the money is to be used for a car, a new home, or even a wedding. Some also use personal loans to clear expensive and high-interest debts.

Generally lasting between one and seven years, personal loans allow more time for the borrower to repay the total amount. Furthermore, monthly repayments are fixed over the duration of the loan.

Be mindful of these three credit traps

Store cards

These are impractical and expensive means to borrow, despite the incentives being offered. There are cards that have interest rates of 30%, and even those that are lower are still better avoided unless the balance can be paid in full all the time.

Payday loans

Payday loans allow individuals to borrow money for a shorter period of time. While it seems that the repayment amount is low, the APR can be taxing and cause the interest rates to skyrocket at about 1,000+% of the principal.

Hire purchase agreements

These are also called conditional sale agreements, which is another common way to purchase rather expensive items such as furniture or cars. The interest rates may not necessarily be bad but it’s the terms that are more restrictive. Compared to credit, these agreements mean that you are not the legal owner of the goods until the money is paid back in full. This means that the item cannot be sold to others, and the inability to pay or falling behind in payments can result in the retailer taking the items back.