6 The debt supermarket: get to know the products
Here’s a run-down of the most common forms of borrowing.
Overdrafts: People often don’t think of this as a debt, but it is a debt. An overdraft is money a bank lends you on your current account up to an agreed limit when you run out of your own money, so it takes your balance into negative territory. So, if you’re £500 overdrawn it means you’ve a balance on your current account of minus £500 which at some point must be paid back. The cost of overdrafts has risen sharply from 2020 with interest rates up to 40% being charged on the amounts overdrawn. If you need to borrow money you should seek alternative sources of credit.
Credit cards: You use a card to spend on up to a certain credit limit set by the lenders, but it’s a debt you must pay back, and you’re billed monthly with the balance. Unless you’re on a limited-time 0% interest promotion, if you fail to pay the debt off each month, you are charged interest, which varies by provider. Even if you pay it off each month, there are some circumstances where you may be charged interest.
Store cards are a form of credit card used for buying from specified outlets. They tend to have much higher interest rates than credit cards.
Charge cards: can be used like credit cards to make purchases and obtain up to two months’ free credit between purchase and paying off the outstanding amount. Charge cards differ from a credit card in that a borrower is required to pay off the entire balance each month. A fee might be payable for the card.
Loans: loans made to individuals, typically with terms of between 1 and 10 years. They may be either unsecured or secured against an asset. Unsecured personal loans are not contractually linked to any assets the borrower buys. These are available from credit unions, banks, building societies, direct lenders and finance companies.
Hire purchase (HP): a form of secured debt where repayments are made over a period, normally of up to 10 years, to purchase specific goods.
Mortgages: loans to purchase property or land, which are secured against these assets. Debt terms for mortgages are normally up to 25 or 30 years (though a few go to 40 years), though as you pay interest, the longer you borrow for, the more interest you pay. These are covered in more detail in Session 4 on understanding mortgages. There are many types of mortgages including equity release mortgage products. The latter are where you can borrow money if there is a sufficient difference between your property’s market value and any existing mortgage on it.
Other (and very expensive) types of credit: these include doorstep lending and ‘payday lending’ and should only be seen as loans of last resort as the charge can be huge. Another form of alternative credit is ‘rent-to-own’ which is like hire purchase (see above) but is also very expensive as it’s a high cost means to buy household goods. These types of loans tend to be marketed at people on lower incomes or with poorer credit histories and have been subject to a number of clampdowns by the authorities over poor sales tactics. A link is provided at the end of this session to the Financial Conduct Authority’s guide on alternatives to these forms of borrowing.
Peer-to-peer (Peer2Peer) loans: this is an emerging form of lending where special websites link people who have money to invest with individuals or companies wanting to borrow, so you’re effectively borrowing from other individuals rather than a bank. The sites, such as Zopa and Ratesetter, profit by taking a fee.
Personal contract purchase (PCP): an increasingly popular form of car finance. These normally involve making a monthly payment for 2 or 3 years, at which point the residual sum left to be paid off on the car purchase is the same as its trade-in value. At this point, consumers can either make a one-off payment to complete the purchase, trade the car in for a new one (and a new PCP deal) or simply give the car back (subject to the ‘wear-and-tear’ provisions in the contract).
Student loans: these are used to finance further and higher education studies. These are, though, not like ordinary loans or other forms of credit. The debts are only repayable when (and if) the income threshold for repayments is exceeded when former students are in employment. Student loan repayments are, in effect, another form of income tax.
Table 1 provides a summary of the key figures of debt products.
Table 1 Debt products: key features
|Product||Secured/Unsecured||Interest type (typical)||Interest charged (typical)|
|Charge card||Unsecured||Variable – charged only if full monthly amount due is not paid||High (if charged)|
|Loans||Usually unsecured||Fixed||Quite low|
|Hire purchase||Secured||Fixed||Quite high|
|Mortgage||Secured||Fixed or Variable||Usually the lowest for all forms of debt|
|High-cost credit (e.g. payday loans)||Unsecured||Variable||Extremely high|
|Peer-to-peer loans||Unsecured||Variable||From quite low to very high|
|Personal contract purchase (PCP)||Secured||Fixed||From quite low to quite high|