The range of loan options available to borrowers has never been more varied. But with each method catering for different needs and some harbouring nasty surprises - such as 4,000% interest rates - it's important to find the right loan for the right purpose. Here, we run through the best and worst ways to borrow, starting with the baddies.
Find the best loan for you
need little introduction. In theory, a quick cash loan to cover unforeseen, emergency expenditure is perfectly viable. Generally, payday lenders – the likes of Wonga, QuickQuid and GetSomeDosh - offer quick and easy unsecured loans of up to £1,000 over 30 days. But in return for easy money, annual percentage rates (APRs) of interest can stretch into the thousands.
While lenders argue emphasis on the high APR
is a misrepresentation as the money is not lent over a year, critics say the loans target the most financially vulnerable, whose debts can easily snowball out of control. In March, a report by the Office of Fair Trading found payday lenders make the majority of their money from missed repayment fees and interest accrued.
It also found aggressive debt collection methods and a failure to carry out thorough affordability assessments. It issued the 50 companies involved an ultimatum – shape up or lose your licence.
Tim Moss, moneysupermarket.com's head of loans, says: "Payday loans should be used as emergency money and nothing else. But be extra wary of companies that charge the same to borrow for eight days as they would do for 30."
Another blossoming sector of the short-term loan market is guarantor loans. Aimed at people with poor credit records and young people without a credit history, guarantor loans normally offer a way of borrowing up to £7,500 over one to five years, with a second borrower guaranteeing the loan.
Amigo is a typical provider, with an APR of 49.9% but it does not charge any fees. James Benamor, Amigo's chief executive, says: "It's an alternative to borrowing money from your family and friends."
However, Moss points out that while lenders have double the security of a normal loan, the borrower risks the demise of personal relations with their guarantor should they struggle to keep up with repayments.
A third option to consider is credit unions. Member-owned and not-for-profit credit unions can offer competitive rates on small loans. By law, they cannot charge more than 2% a month interest or 26.8% APR.
As the name suggests, secured loans use your home – or sometimes your car – as security. Secured loans can lend sums of up to £250,000 but it depends on the value of your home – generally, the maximum loan-to-value (LTV) ratio is 90% but 70% is usually the norm.
The loans can be relatively easy to obtain since lenders are comfortable with the security of your property. Effectively a second mortgage, it can take time to organise since your house will need to be valued. The timescale of the loan can extend to around 20 years, with APRs hovering around 6% to 15%.
Failure to keep up repayments could result in your home being repossessed and sold to cover your debt.
Paul Crayston, a spokesperson for National Debtline, says: "You have to be absolutely certain you can make the repayments as you could lose your house. I would go as far to say do not take a secured loan
without first seeking free, impartial advice."
It's normally better to opt for an unsecured loan
instead. APRs on personal loans are currently very competitive, with Derbyshire Building Society
offering a 5.1% rate on loans between £7,500 and £14,999, with lots of other providers not far behind.
On the face of it, this is one of the best ways to borrow but there's no guarantee you will be able to secure such a tantalising rate as banks will take your credit history into account.
Despite the negative connotations attached to overdrafts, they can be a very effective way of managing a loan. However, it is vital to distinguish between unauthorised and authorised overdrafts. "Unauthorised overdrafts can be the most expensive way to borrow money and you should do whatever you can do avoid slipping into one," says Crayston.
The fees and charges can equate to more than 2,000% APR, with daily penalties often putting a return to the black out of reach. However, authorised overdrafts arranged in advance can sometimes be interest-free up to a certain amount (First Direct, for example, offers current account
holders a £250 interest-free overdraft
) but more generally they provide a comfortable buffer for borrowers.
Competitive rates normally tickle 16% and so should only be used as short-term fixes.
And so we arrive at the cheapest way to borrow money – interest-free credit cards. The best deals tend to offer 0% on purchases and balance transfers for anything up to 24 months, although a 2 to 3% balance transfer
fee is likely.
Such cards are great for big purchases where you can pay off a lump sum over a number of months and not worry about it accruing interest. Similarly, balance transfers allow you to consolidate your debts cheaply and pay off more expensive loans. However, it's important to know that 0% on balance transfers doesn't necessarily mean 0% on purchases.
Whatever way you borrow money, remember they can all turn bad if you fail to manage your debt responsibly.
Top three borrowing mistakes
1. Pushing it to the max - exceed an authorised overdraft and you will be charged daily and maxing out your credit card
will be seen as a sign of financial stress.
2. Beating your credit into the ground - if you have been refused credit, don't keep applying to different providers as each rejection will leave a further mark on your lending history.
3. Forgetting about fees - many loans come with any number of fees and charges, so make sure you know what they are before you commit.
Short-term cash loans designed to be borrowed mid-way through the month to tide the borrower over until they next get paid, whereupon the loan is settled. Generally used by people with bad credit ratings and/or no access to short-term credit such as an overdraft or credit card. Like logbook loans, this type of borrowing is hugely expensive: the average APR on payday loans is well over 1,000% and in some instances can be considerably more.
As the name suggests, secured loans require security, or “collateral”, usually in the form of property, a motor vehicle, or another valuable item, as a guarantee for the loan. This effectively reduces the level of risk to which a lender is exposed, as the lender has a claim against your home, or other effects, if you default. Secured loans are often available at competitive interest rates. Types of secured loans include mortgages, logbook loans and some types of hire purchase where the loan is secured on the goods you’re buying and these are repossessed if you default.
Unsecured loans mean the loan is not secured on any asset you already own, such as a house, car or other assets and so is a riskier prospect for the lender. Therefore, they usually come with higher interest rates than their secured counterparts, are less flexible and levy high redemption penalties. Most “personal” loans are unsecured.
An overdraft is an agreement with your bank that authorises you to withdraw more funds from your account than you have deposited in it. Many banks charge for this privilege either as a fixed fee or charge interest on the money overdrawn at a special high rate. Some banks charge a fee and interest. And other banks offer a free overdraft but impose very high charges for exceeding the agreed limit of your overdraft.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
Moving money from one account to another, whether switching bank accounts or more likely transferring the outstanding balance on your credit card to another card that charges a lower – or 0% – rate of interest. Some card providers may charge a transfer fee that can be a percentage of the balance transferred.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
This is used to compare interest rates for borrowing. It is the total (or “gross”) interest you’ll pay over the life of a loan, including charges and fees. For credit cards where interest is charged at more frequent intervals, the APR includes a “compounding” effect (paying interest on interest). So for a credit card charging 2% interest a month (equating to 24% a year), the APR would actually be 26.82%.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.