When considering a loan, it pays to look at all the options, including the representative rate, the term, the monthly repayment and total amount payable.
There are five important descriptions of interest rates you need to get your head round.
If you’re comparing personal loans, consider the APR, or annual percentage rate. The APR gives you the interest rate that you pay over the life of the loan. The APR enables you to compare loans from different providers, however they must be exactly the same amount and term.
The representative APR is the rate you will see in advertisements. It is the rate that the advertiser expects at least 51% of successful applicants to receive. Depending on your personal circumstances, you may be quoted a lower rate or a higher one, the representative APR is only an indication of what you might receive.
For the best way of comparing loans of the same amount but with differing lengths and interest rates, ask for the total amount repayable. This is the total amount of money you have to repay the lender over the entire life of the loan.
This is the number of months that you will borrow money for. Provided the amount and APR are the same, the longer the term, the lower the monthly repayments, but you will be paying interest for a longer time, so the total cost will be higher.
It is important to consider the monthly repayments of a loan, to make sure that you can afford the payments and budget on a monthly basis with confidence.
If you’re offered low, easy payments on a loan it may seem a good deal. But if you’re paying low monthly repayments and the APR is high, it will take you longer to pay off the loan.
The longer you have debt the more it will cost you, however you must make sure you can afford the monthly repayments.
All forms of borrowing get you into debt, whether you’ve an overdraft, a bank loan, a credit card, or just borrowing a fiver off a mate.
Apart from choosing what you get into debt for, you should think about the best way of borrowing the money you need.
Mortgages and loans are usually chosen to buy things of high value which will take a long time to pay off such as properties and cars. These types of lending are designed as long-term loans to be repaid over more than a year.
There are a variety of ways to borrow money. They all attract a different rate of interest and they all have different uses.
When you take out a secured loan, you offer something as security for the money you’re borrowing. It could be a piece of property such as a house you own, a diamond ring, an insurance policy which has a cash-in value, or the money in a savings account.
A secured loan should generally have a lower APR because the lender takes in to consideration the security offered.
Unsecured loans are offered without the need for you to prove you have valuable assets such as property or money in the bank. An unsecured loan will generally have a higher APR because the lender takes in to consideration that no security is offered.
The government offers these loans to cover tuition costs and some living costs, and it’s the cheapest long-term debt you can get. Better still, you don’t have to start repaying it until you’re earning over more than £21,000 a year (if your course started after 1 September 2012).
Mortgages are a type of secured loan, used for buying property. The property you’re buying must be worth more than the amount of the loan.
Currently, in order to arrange a mortgage, you will have to pay a proportion of the buying price as a deposit. This may vary with the amount borrowed, the terms of the mortgage, or your credit rating.
Overdrafts are designed for short term borrowing, often used in an emergency to help until pay day. Credit card borrowing provides the facility of being able to pay for things instantly (up to your card limit) and then pay it off as you can afford to subject to the minimum payment required each month.
Credit cards and overdrafts generally come with higher standard interest rates and fees than a traditional loan (although often credits cards start with a low rate and then increase to a higher rate once the promotional period has finished). Store cards (Halifax do not offer store cards) generally have an even higher interest rate.
Credit cards though generally offer an interest free period on purchases – if you repay the total amount you have spent within that period any purchases you make will not incur interest. However if you are thinking of buying a more expensive item that will take you longer to pay off it will be worth comparing interest rates between your credit card and a loan as a loan may be cheaper.
An overdraft is a type of borrowing facility. It lets you borrow money through your current account in the short term to tide you over. Think of it as a back-up pot to dip into until pay day. As long as you’re careful, using your overdraft facility can be a perfectly reasonable way to manage your money.
An overdraft you have agreed in advance with your bank. With an arranged overdraft your bank will agree to an amount you can borrow - this is your arranged overdraft limit.
The fee you will be charged at the end of each day you use your arranged overdraft.
A credit card allows you to borrow money – up to a preset limit and at a variable APR.
Unlike a loan, you don’t usually borrow the money as a lump sum, but bit by bit as you use it to buy things.
Credit cards require you to pay back a minimum amount, or the full balance if it's below the minimum amount.
However at any time you can pay off the full amount, or you can arrange to pay a fixed amount every month that suits you. Remember the quicker you pay your credit card balance back, the less interest you will be charged.
If you keep building up the amount of money you owe on a credit card, but are only paying the minimum amount each month it will take you longer and longer, and cost you more and more in interest.
Always pay off as much of a credit card as you can.
Store cards are similar to credit cards but they are issued by stores for use solely in their shops. They attract customers by offering special deals, but they tend to charge very high interest rates.
They also allow you to pay off a minimum amount each month so that the special savings you make when you buy something are more than wiped out by the interest costs.
However at any time you can pay off the full amount, or you can arrange to pay a fixed amount every month that suits you. Remember the quicker you pay your store card balance back, the less interest you will be charged.
Pay off short term debts like credit cards and overdrafts sooner rather than later. Convenient lending is usually a more expensive option.
If you borrow money, you will be charged interest. And you’ll find that the interest charged on loans and credit cards is much higher than the interest you can earn on savings.
If you borrow £1,000 at 20%, the debt quickly builds up
Year 1 £1,000 + £200 interest = £1,200
Year 2 £1,200 + £240 interest = £1,440
Year 3 £1,440 + £288 interest = £1,728
Year 4 £1,728 + £346 interest = £2,074
Year 5 £2,074 + £414 interest = £2,488
Year 8 £3,583 + £717 interest = £4,300
These calculations are only illustrations and based on not paying back any debt during the 8 year period.
WIth any form of debt, you'll need to make a minimum monthly repayment or you'll have to pay charges and fees. If you only pay the minimum amount required your debt will take much longer to repay as interest is added to the overall balance.
It's important to consider the monthly repayments of a loan, to make sure that you can afford and budget for them with confidence each month.
If you're offered low repayments on a loan it may seem a good deal. But if you're making low monthly repayments, and the APR is high, it will take you longer to pay off the loan.
The longer you have debt the more it will cost you.
Your credit rating will take into account your assets – such as property – but equally importantly it is based on what banks and other organisations think about your ability to borrow and repay money.
Interestingly people who have borrowed money and paid it back as planned often have a better credit rating than those who have never borrowed. This is because they’ve proved they can manage their money in agreement with lenders.
So borrowing money helps to establish a good credit rating, but only if you make the agreed repayments on time.
If you want to check your credit rating you can do so by getting in touch with any of the three main credit agencies, Equifax, Experian or Callcredit who will be able to provide you with a credit report.
Build up your credit rating by only borrowing what you know you can afford to repay.