Borrowing (P)

8/12/2019 Borrowing (P)

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Eastbourne Citizens Advice Bureau

Financial Literacy

BORROWING

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Types of borrowing

Many of us will need to borrow money sometimes and there are several

ways to do this. Some ways cost a lot more than others.

In this unit we will look at how borrowing money works in various forms

including:

• loans

• overdrafts

• credit cards

• credit agreements

• interest free credit

• store cards

• hire purchase

• consolidation loans

• mortgages.



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Who do I borrow money from?

You could borrow money from a friend or family member, in which case

the arrangements for paying the money back are entirely up to you.

Although friends and family are less likely to charge you interest and will

probably be more flexible with repayment, borrowing money from people

close to you can sometimes put a strain on your relationship.

In comparison, borrowing from a bank or building society is a business

transaction with clearly defined rules to follow.



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Fact

In November 2004 the Bank of England announced that the amount of

money borrowed by UK consumers had reached £1 trillion.

That’s one million million pounds.

Citizens Advice has seen a 44 per cent increase in the number of

people seeking help for debt problems over the past six years.



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Loans

When you borrow money from a bank or other lender you enter into a contract

with them which governs the repayment.

You have to be 18 years old to be able to enter into such a contract.

Say, for example you arrange to borrow £500 from a bank:

• the bank will offer you a period of time over which you can repay the money

usually stated in months, eg 12, 18, 24 months etc

• the bank will tell you what their interest rate is, stated as an annualpercentage rate or APR

• they will tell you how much interest is charged per month and how much your

monthly repayments will be

• they should also total these figures up so you can see how much you are

paying in total.

You will also agree the means of payment, eg standing order, cash payments,

cheques etc and the date each month when you must pay.

Let’s look at some examples.



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Borrowing example 1

You want to borrow £1,000 as a loan and you compare the price of

repayments over 12 months, 18 months and 24 months.

The interest rate is 17.8% APR

The bank gives you the following figures:



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These figures are examples only.

Loan amount: £1,000 typical APR: 17.8%

Term: 12 months

Initial repayment: £90.91

Subsequent monthly repayments: £90.97

Total amount repayable: £1,091.58


Term: 18 months




Loan amount: £1,000 typical APR: 17.8%Term: 24 months






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Borrowing example 2

These figures are examples only.


Term: 12 months





Term: 18 months





Term: 24 months




These figures are example only

As you can see

from these

figures, although

the monthly

repayments are

lower, you end

up paying more

to borrow the

same amount of

money over a

longer period of

time.



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Annual percentage rate (APR)

The annual percentage rate (APR) of the total charge for credit is a

standard way of measuring the real cost of credit to the customer,

expressed as an annual rate.

The APR is different to a flat rate of interest and more accurately

reflects the true cost.

The formula for calculating the APR is very complex, but basically the

interest and all other charges made for granting the credit (the total

charge for credit) are totalled and then expressed as an annual rate.



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Payment protection insurance 1

When you borrow money most lenders will offer you a form of payment

protection insurance.

• This gives you protection in case you are suddenly unable to pay, forexample due to ill health, an accident or loss of a job.

• It can cover car finance, personal loans, credit cards and store cards,

catalogue debts and mortgages.

• An amount for insurance is added to your monthly repayment.

• Payment protection insurance is normally optional but some credit

arrangements make it compulsory.



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Payment protection insurance 2

• Most payment protection insurance agreements pay only a part of the

balance each month, for a limited period.

• The most common amount paid is 10 per cent for ten months.

• The amount paid off is always equal to or more than the minimum

monthly payment required by the credit card or store card company.

• If you are sick, lose your job and become unable to make your monthly

payments and you have payment protection cover you should contact the

lender and make a claim as soon as possible.

• Check the details of your credit agreement for further information.



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Overdrafts

An overdraft is an agreement with your bank to take out more money from

your current account than it currently contains.

For example, if you have an overdraft limit of £200 on your account you canspend all the money you have in the account plus another £200.

An overdraft can be a good way to borrow money short-term or to have some

funds available to cover emergencies.



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Overdraft example 1

For example: you need £800 to put a deposit on a

flat. At present you only have £600 in your account

and your pay goes into your bank account in two

weeks time.

• You arrange an overdraft of £300 with your bank.

• You write a cheque for £800 for the deposit.

• When the cheque is cashed your account shows

a balance of -£200. This gives you up to £100 tolive on until your wages go into your account.

• You spend an extra £75.

• Your wages of £900 go into your account.

• What does your account balance show now?

Account balance

£600

£200

- £275

£625



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Answer

When your wages are paid in, your account balance is £625 minus any

interest charges. Many student accounts don’t charge interest onoverdrafts.



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This is a copy of the terms and

conditions for a typical overdraft fora current account.

Terms and conditions for an overdraft



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The interest rate is

shown as 1.36% per

month.



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Overdraft example 2

Interest rate 1.36% per month.

• In our example you were overdrawn by £275.

• Your wages of £900 were paid into your account.

• Therefore you would be charged £3.74 interest for the

first month.

• The balance minus interest charges after one monthwould be:

Account balance

- £275+£900

£625

Interest charge

- £3.74

£621.26



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Overdraft example 3

How much would the charges be if you remained overdrawn by £275

for 6 months?

Answer

£275 x 1.36% = £3.74 x 6 = £22.44

assuming no other transactions were made on this account.



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The terms and conditionsalso show what happens if

you were to exceed the

agreed overdraft limit.

Charges for exceeding an overdraft limit



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Credit cards

Credit cards give you a separate account from which you can borrow

money.

You can use the card to pay for goods or services in shops, by phone orvia the internet.

When you first obtain a credit card you will have a credit limit. This is the

amount of money you can borrow.

Each month you will be sent a statement that shows:

• each item of spending

• the total balance

• the interest charged

• the minimum amount you can repay this month, usually 5 per cent of the

total balance.



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This is a credit card statement from a

high street lender. Most statements

are sent out monthly.

Credit card statement 1



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Here you can see:

• the amount left over fromthe previous month

• the amount paid since

the last statement

• the amount spent with

the card since the last

statement• the current balance

• the minimum payment

due.

Please note the small print




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A second sheet shows the transactions and charges on the account since thelast statement.

Here you can see:

• the balance from the previous statement = £177.74

• the amount paid into the account since the last statement = £50

• payment protection insurance = £1

• interest on the balance = £2.42.

So: £177.74 - £50 = £127.74 + £3.42 charges this month = £131.16 left to pay




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Paying off the current balance

If you pay off the current balance within one month you pay no interest on

what you borrow. This way using a credit card to pay for things can become

a handy alternative to using cash.

For example:

• your current balance is zero

• you buy a jacket for £50 on 12 March

• you receive your credit card statement on 20 March and the balanceshows £50

• the minimum payment is £5 to reach your account by 2 April

• you pay £50 on 29 March

• no interest charge

• balance now zero.

If you paid only the minimum amount of £5 you would incur interest charges

on the remaining £45. If the interest rate is 1.36% (per cent) per month how

much would your total balance be next month?



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Answer

£45 x 1.36% = £0.61 interest. Total balance = £45.61



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Current balance example

In this example if you continued to pay only the minimum amount of £5

each month how long would it take to pay for the jacket priced £50?



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Answer

It would take 10 months to pay off the balance and you would be charged

£3.33 total interest.

Total cost £53.33



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Charge cards

The difference between a charge card and a credit card is that the amount

borrowed on a charge card must be repaid in full at the end of a given

period, usually a month.

Interest is not charged on the amount but you may have to pay an annual

fee for the card.

American Express and Diners Club are the two major operators.



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Credit agreements

• Under credit sale, you buy the goods at the cash price.

• You usually have to pay interest but some lenders offer interest free credit.

• Repayments are made in instalments.

• You are the legal owner of the goods as soon as the contract is made and the

goods cannot be returned if you change your mind.

• The supplier cannot repossess the goods if you fall behind in repayments, but

can take court action to recover the money owed if you don’t keep up the

repayments.

• Credit sale agreements are now more common than hire purchase

agreements and it is important not to confuse the two.



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Interest free credit

This is potentially a good way to purchase goods though it is not often

available.You don’t pay any more than the cash price but have a period of time to pay

for what you’ve bought.

Read the small print carefully. Sometimes a way of paying called ‘nine months

interest free option’ is offered which is very different from ‘interest free credit’.



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Interest free credit offer

Here is an example of an interest free credit offer from one high street

electrical retailer:

Cash price £699.99. No deposit required. Either pay £699.99 within 10

months of the date of purchase, total amount payable £699.99, no interest

charges paid.

Or 39 monthly payments of £32.57 commencing 10 months after the

purchase date. Total amount payable £1,270.23.

29.5% typical APR. Interest calculated from date of agreement.

Buy Now Pay 2006 on everything over £299



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Example from a catalogue retail store

Here is an example from a catalogue retail store:

Spend £195 on a 6 month Buy Now Pay Later agreement on your Store

Card. Pay nothing for 6 months (although you can if you wish) and then

settle the cash price at that point.

Total payable £195.

Or choose to spread the cost over a longer period, paying a minimum 3%or £2 each month (whichever is the greater) and if you only ever pay the

minimum the total payable would be £524.36 (25.9% APR).

Includes deferred interest from the Buy Now Pay Later period.



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As you can see from these examples interest free credit can be a

good deal if you pay the full amount after the free period.

If you don’t pay the full amount in time you could end up paying

more than twice as much for the item.



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Store cards

Store cards are the cards that many major retailers offer their customers

as a convenient way of buying goods in their stores, often with incentives

attached such as special discounts and privileges.

A store card generally:

• is considered as another payment method amongst others such as cash

or credit cards

• has a lower credit limit than a credit card• can be used only at the issuing retailer store.

Store cards operate similarly to a credit card with a monthly statement

being sent to all customers with the requirement to pay off at least the

minimum payment.

When considering a store card, you need to weigh up the costs and

benefits in the same way as you would for other forms of credit.



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Store cards – tips

Before signing up for a store card consider the following:

• Do you really need a store card?

• Do you have other ways to get credit such as credit cards or an overdraft? If so

which has the lowest interest rate?

• Discounts sound tempting but only if you pay off the full balance.

• Is there is an interest-free period? If so how much will the interest be when it

ends?

• Check all terms of the agreement: APR, interest free period, penalties for default

and late payment.

• If payment protection insurance is offered is it worth having? Read the terms and

conditions.

• Beware of persistent shop assistants who try to persuade you to sign up for a

card.

• Don’t be rushed into it. If in doubt take the paperwork home and read it before

signing anything.



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Available from Bank or Building

Society

Bank or other

lender

Shops or stores

Able to get cash? Yes Yes but interest is

charged

No

Able to buy

goods?

Yes in most shops Yes in most shops Only in certain

shops

Can you get

credit?

No Yes up to the

maximum limit

Yes up to limit

How do you pay? Debits from your

current account

Monthly Bill Monthly Bill

Annual Charge? No Sometimes Sometimes

Interest payable? Only if overdrawn Yes if balance not

paid in full each

month

Yes if balance not

paid in full each

month

Debit Card Credit Card Store card

Card Comparison



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Hire purchase (HP)

Under a hire purchase (HP) agreement, you hire goods until you pay the final

instalment. You will not own the goods until then.

• This means that you can end the agreement and return the goods at any time.

• However, you will owe any overdue instalments and, if less than half of the total

price has been paid, you may also have to pay the difference.

• The company which has made the loan (the lender) may be able to take back(repossess) the goods if, for example, you fall behind with payments.

• The lender doesn’t have to sell the repossessed goods to reduce your debt.



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Advantages Disadvantages Conclusion

Allows you to buy more

expensive items on

credit.

It may be easier to get a

Hire Purchase agreement

than a bank loan or credit

card.

You do not own the

goods until you have paid

off the full amount.

The Hire Purchase

company can take back

the goods if you do not

keep up with payments.

If the goods are taken

back you may still owe

money on them.

HP can be more

expensive than a loan or

a credit card.

You can return the goods

and end the agreement

any time as long as you

are up to date with your

payments.

It’s worth considering

other forms of credit first.

Hire purchase



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Mail order

Mail order shopping is usually arranged through a catalogue and is

normally interest free, the customer paying only the price of the purchase

in instalments.

However, goods bought in this way may be more expensive.



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Advantages Disadvantages ConclusionSmall weekly

repayments.

It might be easier to get

catalogue credit than

from other lenders.

Only borrow the price of

goods you buy.

Catalogues may be

more expensive.

Can be higher interest

rates.

Compare with prices in

shops before buying,

Compare interest rates

with other forms ofborrowing before buying.

Mail Order catalogue goods on credit



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Doorstep sellers

• Selling or promoting goods or services on credit by calling at people’s

homes is illegal unless the company has a licence to sell credit outside trade

premises.

• Common examples are double glazing or home improvements. Any

agreement that is made illegally may not be enforceable.

• It is a criminal offence to try to make a cash loan outside trade premises

unless the visit is made to your home in response to a written and signed

request.

• Any agreement that is made illegally may not be enforceable.

• If you have signed an agreement of this type seek advice.



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Credit unions

• A credit union is a self -help co-operative whose members pool their savings to

provide each other with credit at a low interest rate.

• If a member fails to repay a loan, the credit union can seek repayment throughthe courts.

• Credit unions encourage people to save what they can and only borrow as

much as they can afford.

• After you have been saving with the credit union for a few months you can

apply for a loan.

• The maximum interest charge is 1 per cent per month.



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Pawnbrokers

• Pawnbrokers lend money against the value of property left with them. They

must give a receipt known as a ticket.• Pawnbrokers agree to keep the property for at least six months but you can

get it back at any time during that period by paying off the loan plus interest.

• The period can be extended by paying the interest only and re-pledging the

property.



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Loan sharks

• Loan sharks lend money to people who are usually unable to borrow from

other sources.

• They charge very high interest and are not concerned by your ability to

repay.

• They may force you to take out a second loan to repay the first.

• If you get behind with payments a loan shark may threaten you.

• This is illegal and, if you have entered into an agreement with a loanshark or an agreement with excessively high interest, you should seek

advice.



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Consolidation loans

• A consolidation loan is a loan to pay off all your existing debts from

whatever source such as credit cards, loans, overdrafts etc.

• From then on you only make repayments to the new creditor.• The advantage of this is only one payment to remember.

• The disadvantages can be higher interest rates and consequences if you

don’t make payments on time.

• Consolidation loans are usually secured against your home and therefore

are only available to homeowners.

• If you fail to keep up the payments you could lose your home.

• You should think carefully before taking out a consolidation loan. There

may be better, cheaper ways to pay off your existing debts.



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Mortgages

• If you wish to buy a home you may be able to borrow money to do this.

This is called a mortgage.

• The loan is for a fixed period usually 25 years and you have to payinterest on the loan.

• If you do not keep up the agreed repayments, the lender can take

possession of your home.

• Mortgages are available from banks, building societies and other lenders.

This is a very competitive area and the lenders are constantly changing thetypes of mortgage they offer. Because of this it is not possible to cover this

subject in detail here.



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Consequences of borrowing

Before borrowing money you should consider the full cost of paying it

back and how this will affect your budget.

• Can you afford the repayments over a period of time? • You should compare interest rates and opt for the lowest.

• Borrowing money can mean you can buy things now rather than

having to wait to save up the same amount of money.

• Do you really need to buy it sooner rather than later?

• With so many people getting into problems as a result of borrowing

money do you want to be another part of this growing statistic?

• Do you know what the consequences can be of borrowing money and

getting into debt?

Getting into debt



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Getting into debt

• People get into debt for a variety of reasons and it is not always their fault.

• Sometimes reckless spending or bad budgeting is the cause of debt.

• Sometimes it is just bad luck and unexpected change of circumstances.

• Debt is something that can affect anyone at anytime.

• If you find you are having trouble meeting your payments don’t panic and

don’t ignore the problem.

• Get to grips with your finances, review your budget and take action before it

gets out of control.

• Contact lenders and tell them about the problem.

If in doubt seek advice.

For more information visit:

Your local Citizens Advice Bureau www.citizensadvice.org.uk

Direct Debtline telephone 01323 635999 www.directdebtline.com

National Debtline telephone 0808 808 4000 www.nationaldebtline.co.uk

Financial Services Authority www.fsa.gov.uk

http://www.directdebtline.com/

http://www.nationaldebtline.co.uk/

http://www.fsa.gov.uk/

http://www.fsa.gov.uk/

http://www.nationaldebtline.co.uk/

http://www.directdebtline.com/



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Activity 1

‘How would you like to pay?’

Consider the advantages and disadvantages of different ways of paying for

items. Which would you prefer?The following items have various payment options:

ITEM and PRICE Payment options

New clothes: £150 Save up: time taken 3 months

Store Card: 6% APR

Credit Card: 1.5% interest monthly

A laptop computer: £500 Save up: time taken 6 months

Interest Free Credit 6 months: 29.3%

interest thereafter

Credit Card: 1.5% interest monthly

A second hand car: £1000 Save up: time taken 1 year

Hire Purchase:12 months at 2.8%

interest monthly

Credit Card: 1.5 % interest monthly



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Activity 2

A new games console is released in a week’s time at £150. Although you

want one you decide to save up to buy it. You save £10 a week so it will take

you 15 weeks until you can afford it.

Your friend decides to buy one today with a credit card. He pays 18 per cent

APR and pays £40 a month. In four months time he has paid £150 plus £5.57

interest a total of £155.75.

After three months you see the price has come down to £125.

You buy the games console at that price.

Who gets the better deal?



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