Taking out a loan – where to look and what to avoid




Taking out a loan – where to look and what to avoid!

At moneystepper.com, we don’t recommend you taking out a loan. Hopefully, you can design your finances in such a way that there is never the need for a loan. Budget carefully, live within your means and avoid consumer debt. That’s our motto.

However, in your journey to financial freedom, there may be times where this cannot be avoided.

Say you are at the beginning of your financial journey. You have £0 in debt, but also £0 in the bank. You are living paycheck to paycheck. You need a car for work – there genuinely isn’t an alternative. Your car explodes. You need to buy a “new” (always buy second hand) car.

In this case, you may find yourself in the position where taking out a loan is your only option. If you do, you should be fully educated on your options. Our goal is to minimize the cost of borrowing.

Therefore, we have compared the cost of some long-term (around 2 years) and short-term (less than one month) loans.

 

Long-term loans

 

Loan Sharks – AVOID

These are the payday loan equivalent of long term loans. Unregulated and generally very nasty: think Eastenders!

According to a recent Guardian article, borrowers in the UK are paying at least £700m a year to loan sharks. It goes on to state that sixty victims of loan sharks are in witness protection. The £700m figure was a conservative estimate for the illegal loans market. Tony Quigley, head of the Illegal Money Lending Team (IMLT) in England said “It really is hideous what some of the loan sharks do to a community. It is just exploitation and profiteering of the worst kind. We believe we have stopped 25 suicides, from what victims have told us.”

Pretty serious stuff. In case that wasn’t enough, here is a photo of Mr Quigley showing some weapons confiscated during raids on loan sharks.

Taking out a loan - Loan shark

 

Golden rule: never go near a loan shark. Baseball bats are not your friend!

Representative APR: who cares with 60 people in witness protection and baseball bats!

 

Bank loans – CONSIDER

If you do need to borrow long term, bank loans are a much safer alternative. Obtaining an unsecured personal loan from a bank is a fairly straight-forward process. Simply determine how much you need to borrow and the length of time and then search around the banks’ websites to find the lowest rate.

To borrow £6,000 from HSBC over 24 months, for example, would cost £378 in total interest.

Taking out a loan - HSBC

Golden rule: ensure that you can meet the monthly payments and shop around for the best rate for your specific circumstances

Equivalent APR: 6.1%

 

Peer-to-peer lending – CONSIDER

As well as the banks, lenders can look to the peer-to-peer lending industry to borrow money. The premise of this type of loan is that investors directly lend their money to borrowers, thereby removing the middle man of the bank, and in turn reducing the fees and administration that comes with using the bank.

If you borrowed at Lending Works, for example, the same loan as with HSBC would be a little cheaper:

Taking out a loan - Lending Works

There are also many other benefits to using a peer-to-peer lender:

Taking out a loan - Lending Works 2

The key here is the lack of early repayment charges and the flexibility to make overpayments. This means that you can, hopefully, pay down your debt quicker than you had originally envisaged.

 

Golden rule: ensure that you can meet the monthly payments and shop around for the best rate for your specific circumstances

Representative APR: 5.5%

 

Credit Cards – CONSIDER

Although generally considered as a short-term form of financing, the “introductory offers” available with credit cards now mean that these can equate to long-term borrowing.

For example, say you need to make a single purchase for £6k, but you don’t have the cash to hand. Subject to obtaining approval for this level of credit (this will depend on your credit score), you could incur the expense on an existing credit card(s) and then perform a balance transfer to the Nationwide credit card. For a 0.75% upfront fee, this charges 0% on balance transfers for up to 26 months.

Taking out a loan - Nationwide

If you don’t already have credit cards, you could equally obtain a 0% purchases credit card from Tesco which has 0% interest over the first 18 months. This way, you could make the purchase directly on your new credit card and still not pay interest for this period. You would have to make larger monthly payments to pay it down in the 18 month period, but your APR would be 0%.

Golden rule: you MUST repay the balances before the end of the 0% period. Otherwise, your interest shoots up to around 20% APR.

Representative APR (Nationwide): 0.38%

 

Winner (2 years or under) – 0% credit cards

Winner (over 2 years) – banks / peer-to-peer lending

 

Short-term loans

 

Payday loans – AVOID

Avoid, avoid, avoid. At all costs – avoid! These are just the worst.

Payday loans are short-term loans designed to make people poor.

Okay, they may be officially designed to “provide short-term funds to people who need cash quickly”. But effectively, the result is that they make people poor!




At face value, these payday loans don’t seem that expensive. You may say: “it is only £20 or £30 to get me out of this pickle nice and quickly, so its money well spent”. Well, I don’t mean to be harsh, but it was this attitude that got you into this pickle in the first place. This £20 or £30 isn’t cheap at all.

In Wonga’s advert (this is what they are saying to promote their business), their representative APR isn’t 5%, 10% or 25%. 25% would be outrageous, right? No, it is 5853%. No, really…

Taking out a loan - Wonga

Compare to the 0-2% APRs currently available on savings accounts, and we can see how expensive this really is!

 

Golden rule: NEVER take out a payday loan. EVER.

Representative APR: 5853%

 

Overdraft – CONSIDER (but AVOID if not planned)

Is an overdraft a better alternative than a payday loan? It depends. At Barclays, for instance, if you agreed the overdraft up front, the same lending as the payday loan example would be:

Taking out a loan - Overdraft

So this would only cost £1.02 instead of £26.60 – much better than the payday loans.

If you do not have an agreed overdraft, it still costs 19.3%, BUT you have to pay an £8 per transaction fee. Therefore, if you need to pay 2-3 separate bills to make up that £100, then this could be more expensive than the payday loan.

Golden rule: If you are using your overdraft, you MUST make sure that you have an agreed overdraft in place and inform your bank in order to avoid transaction fees.

Representative APR: 20%

 

Bank of Mum and Dad – CONSIDER

How about lending from friends and family? People are often worried about lending from friends and family negatively impacting their relationships.

However, if you are 100% confident that you are going to pay this £100 back in 20 days, you could offer to pay them £1 for the loan. This would save you £21.60 compared to the payday loan, and would be cheaper than going into your overdraft. Moreover, it will save an application form or two – no one likes the red tape!

This is clearly a good deal for you, but what about your friends and family?

Well, this represents a 1% ROI to the lender over 20 days, equivalent to a 20% representative APR. So, as an investment decision for your friends and family, this would be a good business deal, as it outperforms all other investments easily available to them (shares, cash savings, bonds, etc).

Golden rule: Only go down this route if you are 100% confident you can pay the loan back on time. Otherwise, this may impact your relationships.

Representative APR: 20%

 

Credit Card – CONSIDER

The final alternative is to consider a credit card. If you can pay down your loan in 20 days, then you will incur no interest.

You could even go further and obtain a 0% purchases card to allow you much more than the 20 days to pay down your interest.

The lowest standard APR rate currently available is with Sainsbury’s bank at 6.9% APR.

Credit cards, when used correctly, can be a great tool in building wealth. You just have to make sure that you never pay a penny of interest! Educate yourself thoroughly before you sign up!

 

Golden rule: Always pay down your credit card balance in full every month

Representative APR:  6.9% (of 0% if you pay off the amount in full)

 

Short-term loan winner: Credit card (as long as you pay off in full and understand the costs & charges)

 

2 thoughts on “Taking out a loan – where to look and what to avoid

  1. I’d definitely agree and say stay away from payday loans! They are the worst! I have first hand experience from many years ago and though I was able to get myself out of the cycle, it takes a lot of hard work to pay them off in full and not go back. Peer-to-peer lending is a good alternative as is a zero percent credit card introductory offer (as long as the person has a decent credit score).
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  2. I think Payday loans should be avoided at all costs – the interest rates are generally horrible. We are lucky to have an overdraft line with our credit union that costs just a few cents a day. Although I hate paying them a buck or two for interest when we use it, it’s sure better than giving them 30%. Great post!

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