Its-your-money looks at borrowing
Almost all of us need to borrow money at some time in our lives. The good news is that it has never been easier to borrow than it is now. Banks, building societies, credit card companies, major stores are all falling over themselves to lend to us, and the amount we personally owe in the UK now exceeds £1 trillion (a million million). The bad news is that some of this borrowing is very expensive.
Store cards are one of the most expensive ways to borrow
It’s crazy to shop around for a bargain and then buy it using a store card, unless you plan to pay it off in full. If you pay off the minimum amount each month, you will end up paying double the cost of whatever it is you've bought. It’s even worse if you miss some of the monthly payments. The card company will add penalty charges for missed payments and you will pay interest on those too. A typical store card charges you around 27% per year interest, and although they are required by law to state this annual percentage rate (APR), the ease with which you can get instant credit whilst you are in the store can tempt you to overlook how expensive this credit really is. In many cases, shop assistants encourage you to apply for a store card and there are often vouchers or money-back offers if you do. Be warned! If the store is trying hard to sell you something (store card, extended warranty, SCART lead for that really cheap DVD player) then it’s a safe bet that they are making more money out of whatever it is they are pushing than they are from the product you went in to buy in the first place.
Store cards are not all bad news. They usually give you almost two months free credit provided you pay the full amount on time. The same applies to credit cards. You walk out with the goods today and don't have to pay for them until the end of next month. That’s a pretty good deal – as long as you make absolutely sure that the money gets to the card company in time. The best way to do that is by setting up a direct debit, and it’s then up to the card company to make sure the money gets into your account. Giving you this free credit costs the card company, and they get their money back from those customers who actually do need the credit. It is a sad fact of financial life that the least well off get the worst deals.
Beware of loan companies
Loans from companies that specialise in lending to bad credit risks are also very expensive. Often referred to as ‘loan sharks’ these companies argue that because so many of their customers default on repayments (and some people simply vanish), they have to charge what seem extortionate rates of interest to make up for the bad debts. That is a fair comment if their loans are unsecured, but if a loan is secured by a second mortgage on a house then there is a good chance that the company will be able to recover most if not all of its money.
Very recently there was a court case involving a couple who took out a £5,750 home improvement loan and faced losing their house after their debt soared more than £384,000. They took out the loan in 1989 with a company called Home Loans Northern with an annual percentage rate of 34.9 per cent, repayable over 15 years. But within months, the couple began to struggle to make repayments and made none for one period of three years. The debt was subsequently sold on to another loan company. In 1990, the couple were served a repossession order if they failed to pay their arrears. It finally came to court in October 2004. Fortunately, due to special circumstances, the court decided not to enforce repossession and the debt was reduced. But it would be very dangerous to assume that courts will favour the borrowers in similar cases.
What do I do if I get into difficulties with debt?
If you really are struggling, the first thing to do is to ask for free advice from one of several debt counselling services operating as charities (we mention some on our links page), or from your local Citizen’s Advice Bureau. There are also organisations and companies that can help you to reduce interest payments by lumping all your debts together (consolidating them) and replacing them by a single loan at the best interest rate available to you. Many of these debt management companies will charge a fee for their services, and of course one way or another you will be paying. Make sure you exhaust all the free sources of help first. You don’t want to add extra costs to your existing debts.
Many credit cards will give you an interest free honeymoon period of 6 to 9 months when you first take them out. Once the honeymoon is over, you can expect an APR of around 15% a year. Better than a store card but still not cheap. There is a huge range of cards available, and like everything else, it pays to shop around. Several internet sites (see links) and newspapers provide up to date information on the available deals.
Bank loans, overdrafts, and flexible mortgages
The cost of borrowing from a bank will depend very much on whether you are able to provide some security (typically your home) and the level of your monthly income. If you own your home and have a reasonable income (say £2,000 plus a month), then it is worth considering a flexible mortgage/savings account where any savings you have are deducted from the amount you have outstanding on your borrowings before working out the interest. Expect to pay at least 7% interest, and more likely around 10%, although some banks will give you an interest free honeymoon period. Deals change all the time so shop around (see links), and be prepared to haggle.
Unauthorised overdrafts are expensive
What you must never do is allow your bank current account to become overdrawn by accident. Unauthorised overdrafts are expensive. There will be a penalty charge plus a high interest rate. Your bank might refuse to honour a cheque and that will cost you even more. Use your PC to keep track of your bank account so you can see if you are at risk of becoming overdrawn (see links and downloads).
Borrowing to buy your home is the least expensive way of getting cash today in exchange for handing over cash in the future. Although a mortgage isn't complicated there are several considerations and this is an area where a mortgage broker might be worth talking to. Apart from the obvious question of the interest rate, you can choose between fixed and variable rates; there will often be the option of a honeymoon period with a reduced rate for perhaps one or two years; there may be penalties if you redeem the mortgage within, say, the first five years. There are repayment mortgages, where the amount you pay each month includes some repayment of the loan as well as interest; and interest-only mortgages where all you pay each month is interest and the full amount of the loan will be repaid when you sell the property (or win the lottery). And there is the flexible mortgage that we mentioned above. There isn't any single ‘best-buy’ because so much depends on your circumstances.
How much can you borrow?
Normally the bank or building society will lend you up to about 90% of the value of the house you propose to buy and up to around 5 times your annual income before tax. Whilst it is sensible to take into account the cost of any improvements you plan to make when deciding how much you need to borrow, it is also sensible not to borrow more than you can comfortably afford to repay, or more than the property is worth if the housing market turns down. One building society has recently introduced a mortgage offering you even more than the house is worth (up to 130% of the property value). The interest rate is higher than normal and the society is likely to be pretty strict about who qualifies, but it is still a dangerous and arguably irresponsible approach that ultimately helps to fuel a speculative bubble in house prices.
Housing is not a one-way bet
The housing market does turn down from time to time. Although property prices are linked to inflation and economic growth, they don't move exactly in step (the same is true of shares). In recent years, house prices have moved ahead of this underlying trend, largely because of the very significant increase in the number of younger women in well-paid jobs. Mortgage lenders today almost always take account of the woman’s income in deciding how much they will lend to a couple wanting to buy a house. As the demand for houses in the most desirable areas will always exceed the availability, dual income mortgages have simply pushed the prices up that much faster. Although mortgage lenders are taking a risk by helping to create property bubbles, most of the risk is taken by the homeowner. When you take out a mortgage, you are bound to repay the amount you borrowed whatever happens to the housing market. True, you get the benefit of any rise in price, but you carry the can if there is a fall.
For those, usually younger people, wanting to join in the property game, the prize seems always to be just out of reach. Even if they can get a mortgage, they are faced with either paying a higher interest rate because they need to borrow a higher proportion of the property value, or having a fairly large deposit. Having a deposit to put down on a home is an important reason why many people save. We look at savings on the next page.
|9 October, 2008 © 2008 K.R.Wade and Co Ltd|