There comes a point in everyone's lives when we need to spend a big chunk of money on something important. Obviously if the item we're talking about was a house or flat we would know that the best place to turn would be a mortgage lender, and would spend some time finding the best mortgage deal available to us. But what if the money was required to pay for a new car, home improvements or a new boiler?
The best way to fund these types of expenses is by using your savings. For a start, we should all aim to have between three and twelve months' income safely stashed away in an easy access account, ready for any potential emergencies. However, in addition to this rainy day fund, many of us choose to put some money aside in order to pay for things that we know are coming up, such as holidays, etc. If you know your car will need replacing within three years, why not start stashing away some money each month in preparation? This method of 'self-insuring' works for many people and means that when they need to replace an item, they save hundreds of pounds in interest by not needing to borrow. And most people would admit that having a nice lump sum of cash in the bank helps them feel more secure and lets them sleep more soundly.
Of course, many of us may be in the middle of setting up their various savings funds when problems strike. The boiler could die or the car could need replacing urgently, requiring thousands of pounds you simply don't have yet. In these situations, you'll need to borrow money but the critical thing is that you do it as cheaply as possible.
And to make things easier for you, we've listed the different options available and the pros and cons associated with each. By following this guide you should hopefully be able to see straight away which option would be best for you, depending on your borrowing needs.
1. Credit Card
Pros:
- A 0% card for balance transfers will allow you to transfer other debt to your card and essentially borrow for free for up to 12 months (as long as you pay off the balance in full at the end).
- A 0% card for new purchases will allow you to pay for new items and pay no interest for up to 12 months.
- Extremely useful for borrowing smaller amounts if you can pay it off within the interest free period - £5,000 on a credit card offering 0% for 12 months would effectively require you to pay back £417 each month.
- Gain up to 59 days interest free credit each month, as long as the balance is paid off in full
- Spend between £100 and £30,000 and you'll be protected by Section 75 of the Consumer Credit Act, meaning that you can claim from your card provider, should anything go wrong.
- Option to earn cashback, Airmiles or various other loyalty schemes depending on credit card.
Cons:
- A number of 0% cards charge a 2% balance transfer fee (max £50) for each balance you transfer, which negates some of the savings to be made.
- Transferring large balances and paying off the debt in the interest free period would require large monthly sums - £20,000 on a credit card to be paid off in 12 months would effectively require 12 payments of £1,667.
- Using a 0% balance transfer card for new spending could be costly as many providers use negative payment hierarchy.
- If you don't have a 0% card and fail to pay off your balance in full each month they're an expensive way to borrow as some cards feature APRs of over 28%!
- If you fail to pay off your 0% card when the introductory period is up you will pay a small fortune in interest.
- The interest rate you are offered may not be the one advertised.
- You may need to pay an annual fee.
Suitable for:
Short term loans (<1 year) - if you pay off the balance before the 0% deal expires you're getting interest free borrowing!
>> Compare 0% cards in our credit card centre
2. Unsecured loan
Pros:
- You can borrow without giving your lender security (such as your house).
- Rates are so low now that they rival secured loans, but without the risk! You could borrow up to £25,000 for as little as 5.6% APR.
- Simple way to borrow that doesn't put your home at risk if you can't meet the repayments.
- Rates are far cheaper than those offered by car finance firms, etc.
Cons:
- It's not free - you'll still have to pay interest
- You may be tempted to borrow more than you need.
- Rates advertised are typical - you may pay far more.
- Your lender may persuade you to pay for expensive Payment Protection Insurance (PPI) meaning your loan could cost 15-25% more than it would do otherwise.
- You may be penalised with a fee should you wish to repay early.
- If you don't shop around and head straight to a High Street bank you could pay rates that are over double the Best Buys. Always compare deals in our Loan Centre, first.
- You could be stung for arrangement fees and late payment charges if you don't read the small print.
- Choosing to compare just the quoted Annual Percentage Rates (APR) and not the TAR (Total Amount Repayable) could mean you are unable to compare "like with like" and fail to choose the best deal.
Suitable for:
Short-Medium term loans (<5 years) - a cheap way to borrow to pay for a car etc.
>> Pick up a loan in our loan centre
3. Secured loan
Pros:
- Can borrow larger sums (£5k-£100k) at cheaper rates (6.8%) as your lender holds your property as security.
- Can be a cheap method of borrowing larger sums.
Cons:
- Extremely risky - your lender will hold some of your property (your home/stocks and shares etc) as security for the amount you've borrowed.
- Rates are no cheaper than the best unsecured loan rates.
- If you don't keep up the repayments you could lose your home etc.
- You may be tempted to borrow more than you need.
- You may be penalised with a fee if you wish to repay early.
Suitable for:
Longer term loans (>3 years) but you should be aware of the risks involved. You may prefer to choose an unsecured loan.
4. Overdraft
Pros:
- Convenient method of borrowing - simply withdraw the cash from your bank account
- Can be obtained for free - the Alliance & Leicester's Premier Plus current account (apply via the Fool), for example, offers a 0% overdraft for 12 months.
- Can be repaid at any time with no penalty.
Cons:
- Can be an expensive way to borrow. Authorised overdraft fees could be over 17%.
- Very expensive if not organised in advance. Unauthorised fees can be over 27%!
- Extremely easy to inadvertently get into debt due to the ease of borrowing.
Suitable for:
Extremely short-term loans (days!) unless your overdraft is free. Make sure you get yours authorised before dipping into it.
>> Visit our banking centre for a new current account
5. Mortgage Equity Withdrawal
The recent house price boom has increased the value of a vast number of properties, tempting many into remortgage a higher amount than their existing loan. This is often referred to as Mortgage Equity Withdrawal.
Pros:
- By borrowing on the strength of the value of your house (which has risen sharply) it can feel like free money.
- Mortgage rates are usually very low and so this can be a cheap way to borrow.
- You can always sell your home to repay the debt, should you need to.
- Using this cash to improve your home could increase its value even further.
- Making worthwhile improvements to your home can save you from having to move - saving money.
Cons:
- House prices are fickle. If there should be a house price crash, by taking equity out of yours you could actually put yourself into negative equity (i.e. you owe more than the house is worth). Very risky.
- You'll increase your mortgage debt, which can be a shame if you were close to paying it off.
- If you fail to repay the amount of equity withdrawn quickly, you could end up paying up to 25 years interest on it. Even at a low rate this can still add up to thousands!
- For example: Borrowing an extra £10,000 on top of a £100,000, 25-year mortgage at 5% will increase your payments by £59 per month. And if you leave it on your mortgage for the full 25 years it'll cost you an extra £17,537 in interest!
Suitable for:
Short-Medium term loans (<4 years) but you should be aware of the risks. With the housing market relatively uncertain it may be better to take out an unsecured loan, instead.
>> Drop by our mortgage centre if you're remortgaging.
So there we have it, the pros and cons for five of the most popular methods of borrowing available to us. Each one has its strengths and weaknesses and you should certainly make yourself aware of these before taking up a deal. And most of them will cost money!
Aim to get your rainy day fund and savings accounts filled and ready for emergencies and you'll hopefully never have to borrow again!
More: Unsecured Loans from 5.6% | Savings accounts paying up to 5% | Re-mortgage to a cheap deal| Switch to a Better Bank Account
