Eastbourne Citizens Advice Bureau Financial Literacy

BORROWING

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Borrowing

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. Thats 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 annual percentage 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.
Lets 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
Loan amount: 1,000 typical APR: 17.8% Term: 18 months Initial repayment: 62.93 Subsequent monthly repayments: 63.10 Total amount repayable: 1,135.63 Loan amount: 1,000 typical APR: 17.8% Term: 24 months Initial repayment: 49.18 Subsequent monthly repayments: 49.20 Total amount repayable: 1,180.78
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Borrowing example 2

These figures are example only

These figures are examples only.

Loan amount: 1,000 Term: 12 months Initial repayment: 90.91 typical APR: 17.8%

Subsequent monthly repayments: 90.97

Total amount repayable: 1,091.58 Loan amount: 1,000 Term: 18 months typical APR: 17.8%

Initial repayment: 62.93

Subsequent monthly repayments: 63.10 Total amount repayable: 1,135.63 Loan amount: 1,000 typical APR: 17.8%

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.

Term: 24 months
Initial repayment: 49.18 Subsequent monthly repayments: 49.20 Total amount repayable: 1,180.78
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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, for example 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 can spend 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. Account balance 600 200

When the cheque is cashed your account shows a balance of -200. This gives you up to 100 to live on until your wages go into your account.
You spend an extra 75.

- 275
625

Your wages of 900 go into your account.

What does your account balance show now?

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Answer
When your wages are paid in, your account balance is 625 minus any interest charges. Many student accounts dont charge interest on overdrafts.

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Terms and conditions for an overdraft

This is a copy of the terms and conditions for a typical overdraft for a current account.

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The interest rate is shown as 1.36% per month.

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Overdraft example 2
Account balance - 275 +900 625
Interest charge - 3.74 621.26

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 month would be:

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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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Charges for exceeding an overdraft limit

The terms and conditions also show what happens if you were to exceed the agreed 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 or via 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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Credit card statement 1

This is a credit card statement from a high street lender. Most statements are sent out monthly.
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Credit card statement 2

Here you can see: the amount left over from the 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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Credit card statement 3

A second sheet shows the transactions and charges on the account since the last 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 balance shows 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 dont 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 dont pay any more than the cash price but have a period of time to pay for what youve 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:

Buy Now Pay 2006 on everything over 299

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.

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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 dont 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. Dont be rushed into it. If in doubt take the paperwork home and read it before signing anything.

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Card Comparison
Debit Card Available from Able to get cash? Able to buy goods? Can you get credit? How do you pay? Annual Charge? Interest payable? Bank or Building Society Yes Yes in most shops No Debits from your current account No Only if overdrawn Credit Card Bank or other lender Yes but interest is charged Yes in most shops Yes up to the maximum limit Monthly Bill Sometimes Yes if balance not paid in full each month Store card Shops or stores No Only in certain shops Yes up to limit Monthly Bill Sometimes Yes if balance not paid in full each month

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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 doesnt have to sell the repossessed goods to reduce your debt.

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Hire purchase

Advantages

Disadvantages

Conclusion

Allows you to buy more expensive items on credit.

You do not own the You can return the goods goods until you have paid and end the agreement off the full amount. any time as long as you are up to date with your It may be easier to get a The Hire Purchase payments. Hire Purchase agreement company can take back than a bank loan or credit the goods if you do not Its worth considering card. keep up with payments. other forms of credit first. 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.

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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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Mail Order catalogue goods on credit

Advantages Small weekly repayments. It might be easier to get catalogue credit than from other lenders. Only borrow the price of goods you buy.

Disadvantages Catalogues may be more expensive. Can be higher interest rates.

Conclusion Compare with prices in shops before buying, Compare interest rates with other forms of borrowing before buying.

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Doorstep sellers Selling or promoting goods or services on credit by calling at peoples 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 through the 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 loan shark 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 dont 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 pay interest 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 the types 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?

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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 dont panic and dont 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

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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

New clothes: 150

Payment options
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 Save up: time taken 1 year Hire Purchase:12 months at 2.8% interest monthly Credit Card: 1.5 % interest monthly

A second hand car: 1000

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Activity 2
A new games console is released in a weeks 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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Borrowing End

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