What is borrowing?
Borrowing means using someone else’s money to pay for something that you want or need. Some people are reluctant to borrow, preferring to save. Some feel more comfortable with the idea of debt (owing money to someone else), and are happy to borrow if needs be. Others might not feel they have a choice.
Is borrowing a bad thing?
Not necessarily. Borrowing can be divided into two categories:
1. Good debt has the following characteristics:
- It is an investment in your long term future
- It has a positive effect on your overall financial
position - You have a sensible reason for taking on the debt
- You can afford to pay it back
- You have shopped around for the best deal for your
needs
Examples of good debt might include student loans (an investment in your future), mortgages (a roof over your head and a long term investment) and car loans (if you need a car to get to work to earn money).
Some people use their credit card to pay their monthly outgoings and then pay the credit card bill off in full before any interest becomes payable. This is an example of using a credit card in a good way.
2. Bad debt has the following characteristics:
- It is not an investment in your long term future
- It has a negative effect on your overall financial
position - You use it to buy something you don’t really need
- You cannot afford to pay it back
- You have not shopped around and are therefore paying more interest than you need to
Examples of bad debt might include a holiday you can’t afford, the latest electronic gadgets that you don’t really need and borrowing to pay your monthly bills.
Some people use their credit cards to pay their monthly outgoings and then only make the minimum repayment each month. The money left on the card is then subject to interest at quite a high rate. If you only ever pay off the minimum amount on a credit card, you will never pay off the debt and the amount you owe will keep increasing. At some point, the credit card provider is likely to cancel your card and demand the debt be repaid. This is an example of using a credit card in a bad way.
Credit Score
Every time you apply to borrow money, the lender will check your credit file (a file held by a credit reference agency detailing previous borrowings) to help it decide whether or not to lend to you, how much to let you borrow and how much interest to charge you. This means that if you have borrowed before and have either been late with or missed a repayment or two (or more!) then the lender will find out about this and may charge you more interest than they would for someone who has made all their previous repayments on time. Ultimately, they may decline your application.
Ways to borrow
If, after thinking things through, you identify that the money you’d like to borrow represents a good debt, then the following methods of borrowing might be available to you.
Credit cards
- Take out a credit card
- Use it to buy what you need
- Ideally, pay off the full amount before interest becomes payable
Personal loans
- Borrow what you need
- Buy what you need
- Repay a fixed (usually) amount each month
- Interest rates on personal loans are generally lower than on credit cards
Overdraft
- Your current account may allow you to borrow a relatively small amount interest-free, say up to £250
- If you go above the limit, you will be charged interest
- Your credit score may also be affected
Credit union
- If you’re unable to borrow from other sources due to a poor credit rating, your local credit union (an organisation run for and by its members on a not for profit basis) may be able to help
Payday loan company
- If you are unable to access a credit union, a payday loan company may be your lender of last resort
- These companies charge very high rates for short term loans and are best avoided where at all possible
- Unlike a credit union, they are not run on a ‘not for profit’ basis. In other words, they are there to make money from you
Getting help
Many people find it hard to ask for help with managing their money. But if the only option available to you is a payday loan company, then it may well be time to contact an organisation such as the StepChange Debt Charity or Citizens Advice who have experienced debt advisers who can help you make the most of the money you do have and help you get yourself out of debt.
With thanks to our partners over at the NMBA for content.
Up next week – CREDIT SCORES!