Money: Know your credit options
From credit cards to Klarna and overdrafts to loans, here’s everything you need to know about the pros and cons of different ways to borrow
We’ve all read horror stories about spiralling debt, which can make taking out loans or using credit seem scary, but it’s about using the right methods in the right circumstances. “It’s important that credit is managed well and that consumers have all the information before making a decision,” says Sam Jennings, financial advisor from Jennings & Co (jenningsfp.co.uk). “Make sure any credit you take out is from a reputable source, and that you can afford to pay it back.”
USE OVERDRAFTS FOR FLEXIBILITY
Most overdrafts are arranged between you and your bank. Unarranged overdrafts occur when you don’t have an overdraft in place or you go over your arranged overdraft. While some overdraft arrangements are free, most carry a monthly charge, though you only pay it if you use it.
THE PROS You only borrow money you need at the time. They are generally quick to arrange and they help avoid the risk of bounced payments.
THE CONS Your bank can charge you if you go over your arranged limit. It’s also tempting to spend more than you have, as your “available funds” are higher.
PAY WITH CREDIT CARDS FOR PROTECTION
A credit card enables you to pay for goods and services and will have a pre-agreed limit. You have to pay a minimum amount off the balance monthly.
THE PROS Some credit cards are 0 per cent for a period, meaning you pay no fees for borrowing. You are often offered extra protection as a consumer if you pay by credit card, so many people will use a credit card for large purchases like a new sofa and pay off the balance immediately.
THE CONS It can be very easy to spend money you don’t have. Some cards are interest-free, but others accrue monthly interest. Even if your card is 0 per cent interest-free, once that ends, you need to have either paid off the whole balance, transfer to another 0 per cent card (which incurs fees) or pay interest.
TRY A LOW-RISK PERSONAL LOAN
A personal loan is an amount of money you can borrow from the bank with a repayment term. You’ll usually be able to borrow more than you could with an overdraft, and if you’re borrowing over a longer period of time, it will usually be cheaper than using an overdraft as the interest won’t be as high. In most cases, they are unsecured, so you don’t need to put up assets as collateral. Some, however, are secured, meaning if you defaulted on payments, your assets could be at risk.
THE PROS Personal loans can be used for debt consolidation, so you pay off other forms of high-interest credit and keep your debts in one place. They can also be good for larger expenses, like home improvements. The interest rates are generally fixed (though check this) so you can budget for the monthly repayment amounts.
THE CONS You pay interest on your debt. If your credit rating isn’t perfect, you may be offered a loan but with much higher rate of interest. Some personal loans also have arrangement fees included in the APR, so check. To check what you would be likely to pay, moneyhelper.org. uk have a loan calculator.
SPREAD COSTS WITH BNPL
Schemes like Klarna and Clearpay, known as “buy now, pay later”, have become very popular. Klarna offer options such as “pay in 30 days” and “pay in three” (usually the repayments are split over three months). These two products are interest-free.
THE PROS These schemes can be useful if you are ordering products you might want to return, as you don’t have to
have that money in your bank account. They’re also useful for spreading the cost of a purchase if needed, without racking up interest.
THE CONS It’s tempting to overspend if the money doesn’t come out of your account instantly. In fact, Klarna themselves boast on their website that the average consumer spends 55 per cent more when paying through them. “Pay in 30” and “pay in three” are not regulated by the Financial Conduct Authority. Although the companies claim defaulting on payments does not affect your credit score, some consumers say otherwise.
GET HELP FROM FAMILY
Lending between family and friends is very common for small amounts like unexpected bills right up to things like a house deposit.
THE PROS There’s no need for a credit check. You may also be able to agree a lower interest rate, or no interest at all. THE CONS Mixing money and personal relationships can cause problems. Draw up a loan agreement including the amount, terms, time frame and interest charged
(if any). Get an independent witness to sign the agreement and ideally a solicitor. There are also tax implications to informal lending, so lenders should inform HM Revenue & Customs if they receive any interest on their loan.