Need To Borrow? How To Pick The Right Sort Of Loan

Need To Borrow? How To Pick The Right Sort Of Loan

There are several ways to borrow, so it's vital to work out which is best for you Getty When it comes to borrowing, choosing the right type of loan an

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There are several ways to borrow, so it’s vital to work out which is best for you
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When it comes to borrowing, choosing the right type of loan and lender for the job can make your life cheaper and easier.
Overdrafts
Snapshot: Best employed as a safety net to help you through leaner months until you can get back into credit.
What is an overdraft?
An overdraft is where you borrow from your bank by going into a negative balance on your current account.
How do I get one?
Overdrafts facilities are offered alongside most regular current accounts. The limit on how big your authorised overdraft can be depends on your credit score, earnings and the type of account (the amount is agreed when you open the account).
More on unauthorised overdrafts in a bit…
Basic bank accounts – for people with poor credit scores – do not offer overdraft facilities.
If you are switching your current account between providers, it’s possible to take your overdraft debt with you subject to the same checks with the new bank.
How much will it cost?
In April 2020, the Financial Conduct Authority (FCA), which regulates lenders, radically reformed overdraft charges in a bid to make them simpler and easier to compare.
Under the new rules, banks are no longer able to charge more for unauthorised borrowing (when you have spent over your agreed limit) than for authorised borrowing (when you spend within your agreed limit).

Banks were also told to scrap the spectrum of charges – such as monthly interest or set fees and daily penalties for exceeding your limit – with a single uniform APR (annual percentage rate) of around 40%. Most of the major banks (surprise, surprise!) have opted for 39.9%.
The FCA reckons that seven out of 10 overdraft users will be better off under the new rules, including customers who frequently exceed their agreed limit.
However, if you tend to spend most of the month somewhere within your authorised overdraft, you are likely to be among the three-in-10 who are now worse off by now paying 39.9% APR. You can check out alternative ways of borrowing below.
Student bank accounts and a handful other current accounts offer interest-free overdrafts up to a certain limit, or for a given period.
How do you pay it back?
Overdrafts don’t have a repayment schedule, or even an obligation to pay it off, so getting ‘back into the black’ requires a good dose of self-discipline.
If you are keen to clear your overdraft with a one-off lump sum, consider a money transfer credit card. These pay cash straight into your current account and charge no interest for up to 24 months, for a typical 3%-4% fee (calculated on the amount you transfer).
Top tip: Try to remain within the first 50% of your agreed overdraft limit. It will show as healthy ‘credit utilisation’ on your credit score, indicating that you are managing your money sensibly.

Pros: Easy access, rolling credit, no monthly repayments
Cons: Can be expensive, requires discipline to pay off

Note: While the FCA’s overdraft reforms of overdraft charges were implemented in April as planned, the regulator also ordered banks to offer the first £500 of all overdraft borrowing interest-free, as part of a package of measures to help consumers during coronavirus. This is due to end in mid-July.
Credit cards
Snapshot Best employed for 0% borrowing and for access to consumer protection when making purchases of more than £100.
What are credit cards?
Credit cards provide access to a line of credit, the limit of which will be determined by your credit score and income.
If you plan to borrow on a credit card – opposed to using it for spending and clearing the balance every month – choosing the right type of plastic is of paramount importance.
Here are the best types of credit cards depending on the purpose of your borrowing:
Buying a big-ticket item: Look for a 0% purchase credit card which does not charge interest for a set period – 24 months is the current market leader. You can then spread the cost over that length of time.
Clearing existing credit card debt: Look for a 0% balance transfer credit card which does not charge interest for a set period (currently up to 30 months) when you transfer debt from a card or cards held with a different banking provider(s).
A one-off fee is usually payable of around 3% of the amount transferred, although fee-free options are available in exchange for a shorter interest-free window.
Paying off your overdraft or getting cash: Look for a 0% money transfer card. It works exactly like a balance transfer card but pays the credit as cash into your current account instead.
Interest-free periods of up to 30 months are available with transfer fees of around 3%. Again, fee-free alternatives are available for shorter 0% periods.
With any of these cards, it is crucial to pay back the borrowing before the 0% grace period expires. Otherwise, standard credit card APRs will kick in and the debt can suddenly become very expensive – more on this below.
How do I get one?
A comparison website is the best place to compare and apply for a credit card. Use an online eligibility checker first to protect your credit score from the prospect of failed applications, which can further weaken your credit score.
Bear in mind, the most attractive 0% credit card deals are inevitably reserved for applicants with the best credit scores.
How much will it cost?
Interest charged on credit card balances and purchases is high – starting at around 18% APR (variable), rising to up to 40% if you have poor credit.
You can withdraw cash on your credit card from an ATM but interest charged is considerably more than when using it to make purchases. Charges will also kick in straight away and will apply even if you clear your balance in your next monthly statement.
How do you pay it back?
Credit cards providers require you make a minimum payment every month. This is commonly 1% of your balance, plus that month’s interest, or a fixed sum of £5 – whichever is greater. But you can choose to repay anything over and above this.
It’s not mandatory to set up a direct debit to pay your credit card but it’s a good idea (for the minimum repayment, at least). Late or missed repayments will trigger fees as well as have a negative effect on your credit score.
Tip: It can be almost impossible to pay off credit card debt by making only the minimum repayment. Paying back 1% a month (plus interest) on a £3,000 card debt charged at 18.9% APR for example, would take more than 100 years.

Pros: Can borrow at no interest if used wisely, purchases of more than £100 up to £30,000 are covered under section 75 of the Consumer Credit Act.
Cons: Expensive when paying interest, charges apply for late or missed payments, no set repayment structure

What about store cards?
Store cards work in the same way as credit cards but can only be used in a single store or chain of stores.
APRs on store cards tend to be even more expensive than credit cards – around 29.9% (variable) – while their advantages are limited. For example, you may receive discounts or points for spending in store.
Personal loans
Snapshot Best employed for covering the cost of a one-off large purchase, and paying off the debt steadily over a fixed period 
What are personal loans?
A personal loan is also known as an unsecured loan because it is not secured against an asset, such as your property or car.
Typically, you can borrow between £1,000 and £25,000 on a personal loan. Higher amounts are available, although usually only to existing banking customers with good track records with the lender.
Repayment terms on personal loans vary between 12 months and five years, during which time you make fixed monthly repayments. Interest is typically fixed too, but not always so it’s worth checking.
Because you get a lump sum payment, personal loans are useful for funding one-off big ticket items, such as a wedding, new car or home improvements.
How do I get one?
You can compare deals and apply for a personal loan online – you don’t have to go to your own bank.
How much will it cost?
The APR you are offered on a personal loan will depend on factors such as your credit score, the size of the loan – highest rates apply to borrowing under £3,000 – and your personal circumstances.
The rate you are offered could be much higher than the APR you see advertised – this is only ‘representative’ which means it must be offered to 51% of successful applicants. The other 49% are likely to pay more.
If your credit score is very good, you may find better personal loan rates from a peer-to-peer lender such as Zopa or RateSetter. These are online platforms which match up people looking to borrow with registered investors.
How do you pay it back?
While repayments on a personal loan are fixed over your chosen term, you can pay it off in full at any time – usually for a fee of one or two months’ interest.
You can make partial overpayments on your loan penalty-free. But if the extra repayments exceed £8,000 in a single year your lender can charge you, but only if it has also incurred a cost.
Tip: Using an online loan eligibility checker before you apply will set out the deals you’ll be most likely to be accepted for and will not show up on your credit report.

Pros: Fixed repayments are good for budgeting, can be a cheap way to borrow, approval is usually quick
Cons: May cost more than the advertised APR, other forms of credit could be cheaper and more flexible

Secured loans
Snapshot – Best employed for large costs such as home improvements or larger debt consolidation – and only if you are unable to borrow through other means
What are secured loans?
Unlike a personal loan, a secured loan is secured against an asset – usually your property. Where this is the case, it can also be known as a homeowner loan or second charge mortgage.
Minimum secured loan amounts are usually around £25,000, although some providers offer as little as £10,000. Repayment terms range from three years to 25 years and beyond.
How do I get one?
You will need to be a homeowner with enough equity (the difference between your mortgage debt and what your property is worth) for the loan to be secured against.
As the lender has a legal claim over your home if you default on repayments, you don’t need an especially good credit score to be accepted for a secured loan – although the lender will still run the usual checks.
You can compare secured loans on most comparison websites – but this is not a form of borrowing to be taken lightly. As the many legal caveats around these deals point out, your home is at risk if you default on repayments.
How much will it cost?
Because the lender has collateral, interest on secured loans tend to be relatively low compared to other forms of borrowing, starting at around 6% APR. Fixed and variable rates of interest are available, often depending on the loan and term you choose.
How do you pay it back?
With repayment terms of up to 35 years, monthly costs on secured loans can be low – but the longer you take to pay it back, the more interest you will pay overall. This means that, despite their low APRs, secured loans can be an expensive way to borrow.
Like personal loans, secured loans are regulated under the Consumer Credit Act. This means you will be able to repay the loan in full at any time at a charge of one to two months’ interest – but it becomes especially important with secured lending to check the small print thoroughly.
You can also make partial overpayments penalty-free. But, again, if the extra repayments exceed £8,000 in a single year your lender can charge you, so long as it has also incurred a cost.
Tip: Exhaust all other forms of borrowing options before taking a secured loan – including taking a further advance with your mortgage lender (more on this below). Extra debt secured against your property not only means you risk losing your home, it can limit your financial options and flexibility in the future.

Pros: Relatively easy to get, cheap APRs, low monthly repayments
Cons: Your property is at risk, lengthy repayment terms, interest is often variable so can increase

Increasing your mortgage
One alternative to a secured loan is a further advance from your current mortgage lender. This is effectively extra borrowing against the value of your property (which may have increased) and will be subject to the usual credit and affordability checks.
A further advance will be treated as a separate loan and therefore priced on the deals your lender is offering at the time, rather than at your existing mortgage rate.
In this case, try to line up the two parts of your mortgage. For example, if you only have one year remaining of a fix on your primary mortgage, you may want to avoid two-year tie-ins on your top-up loan.
You can spread the cost of the borrowing over the remaining tern of your mortgage or perhaps even longer – but this will mean paying more in interest.
If you take out a specific deal, such as a two-year fix, early repayment charges will apply. However, most mortgages allow penalty-free overpayments of up to 10% a year.

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