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Money: THINK before you borrow

Need to take out a loan? There’s lots to consider before you sign on the dotted line

TAKING out a loan can be an expensive way to raise cash fast, but for some people it is the only way to make ends meet.

The collapse of giant payday lender Wonga has not deterred consumers from borrowing money, with the average UK household owing £1,384 in personal loans.

In fact, personal lending from Britain’s biggest banks and building societies has increased four times faster than wages since 2013, and shows no signs of slowing.

The latest figures from UK Finance reveal that the nation has outstanding personal loans worth £37billion, which excludes student loans, credit cards and payday lending.

One of the largest growth areas is car finance, which saw a 100 per cent rise between 2011 and 2016, according to the Financing and Leasing Association.

Handled correctly, a personal loan can be a welcome source of income, and improve your credit rating as long as you can successfully manage the debt. But before you make a loan application, make sure you understand just what you are signing up for.

Check you really need it

The first question to ask yourself is: do I really need to borrow this money? It may be better to be patient and save money for a period of time, so you can buy an item outright without having to pay any interest.

This may also be a quicker and more efficient option, because loan terms can be spread across several years.

‘People tend to view the cost of a loan as the amount they are paying back each month, and don’t focus on how many months they are going to be paying it back. They need to think about what they are going to pay back over the longer term,’ says Caroline Siarkiewicz, head of debt advice at the Money Advice Service.

For example, if you needed to raise £600 to buy a new sofa, you could save £50 a month for a year. But a loan of £600 would cost you £742 over a year with monthly payments of £61.84, based on the best rates at money.co.uk. With a longer-term loan of five years, you would pay £23.72 a month but end up paying back £1,423, more than double the amount you originally borrowed.

There are a variety of saving schemes available, from tax-free ISAs to the government’s new Help To Save account for people receiving Working Tax Credit or Universal Credit. For every £1 you save, you get a bonus of 50p, and you can save up to £50 a month.

Assess the alternatives

A personal loan is not always the best solution, although it will vary with each individual’s circumstances.

A zero per cent credit card could give you an interest-free loan and, providing you pay the entire balance within the zero per cent period, it will stay interest-free.

Another option is to make use of a bank overdraft, which may have lower interest rates than a loan, or to ask the bank for an extension.

‘The key is not to choose a loan as the default option. See what else is on offer before you make the decision,’ says David Baddeley, of financial comparison site finance.co.uk.

It is also important to take your time and not rush into any decisions. Research the different options and don’t be afraid to seek free help and advice. Spending a little time could save you a lot of money.

Consider a joint loan

If you are in a couple, you might be able to borrow more money and spread the costs between two of you. In this situation, you need to consider your joint household budget and what you can afford together.

Do note, though, that this is a slightly riskier strategy because you will be responsible for the whole debt if the relationship breaks down, meaning you could end up with double the debt on your hands.

By signing a credit agreement for a loan with someone else, you are each agreeing to pay off the whole debt if the other person can’t — or won’t — pay.

It doesn’t matter who spent the money or owns the items bought with the joint loan, as both parties share responsibility and liability.

The situation is the same whether you are married, in a civil partnership or not in a relationship at all, as it is possible for friends or relatives to apply for joint loans.

Know your credit score

Your credit rating can have a massive impact on the interest rates and the products available to you. Before you start applying for a loan, it is worth checking out your credit score so you are able to assess your financial CV.

Remember that having no credit history can be damaging, too, as you are unable to demonstrate an ability to pay back debt.

Consumers have a legal right to access their credit report for free from any of the three credit reference agencies: Experian, Equifax (which works in partnership with ClearScore), and Callcredit which operates Noddle.

There is a common myth that being refused credit will damage your credit score and reduce your chances of successfully applying next time round. However, credit agencies do not know whether your loan application has been successful or not.

‘What can damage your rating is making several applications for credit in quick succession. It’s best to check your credit rating before you apply for a loan, so you have a better understanding of which loan companies are likely to say yes,’ says David Baddeley.

Shop around

There are thousands of different products on the market which offer various interest rates and fees and come attached with a variety of terms, conditions and restrictions. Shop around, use comparison websites and do your research.

‘Speaking to others about their experiences and reading reviews can give you a good sense of what the loan provider is really like,’ says Julia McColl, head of customer at services provider Chetwood Financial.

An option worth considering is credit unions — community savings and loan co-operatives which aim to lend money at low interest rates.

These are owned by and run for the benefit of the members who use its services, and interest rates can vary up to the legal maximum of 3 per cent per month, which is an annual percentage rate (APR) of 42.6 per cent.

You must join a credit union before you can take a loan from them, but there are no hidden charges and no penalties if you repay the loan early.

Think ahead

It is crucial that you draw up a budget to see if you can afford to take on any new borrowing. But you also need to consider what might happen if your circumstances change.

Could you afford the monthly loan repayments if you fell ill or lost your job? Use the Money Advice Service’s loan calculator to assess the whole cost of a loan, rather than merely fixating on the basic interest rates.

Read the fine print

Although it is important to consider the interest rate of a loan, you must also take into account fees and charges to calculate what is the best deal overall.

A quarter of consumers who have taken out a loan in the past five years — some 2.6 million people — have been charged unexpected fees, according to new research by loan company LiveLend.

By reading the fine print, and asking questions, you can assess the rates for loan fees, late payment charges or early repayment charges.

Also look out for fees for same-day funds, which is when a loan is deposited into your account the day of your application.

Check their credentials

Always ensure that any loan company with whom you sign a contract — also known as a credit agreement — is regulated by the Financial Conduct Authority (FCA) so you are fully protected by the law.

Never consider borrowing money from a loan shark, no matter how desperate you are, because you will soon find the interest rates spiralling and they may resort to aggressive and illegal tactics to secure repayments.

Loan sharks are unregulated and are not registered with the FCA, which keeps up-to-date details of all the authorised lenders.

If a lender isn’t listed as having a current authorisation to lend money, don’t borrow money from them and don’t let them come into your home.

Similarly doorstep lenders, who often deal in small amounts from £50 to £500, are best avoided. Even if they are regulated companies they have a much higher interest rate than a bank loan or credit card.

If it gets too much, talk

If your situation changes and you find yourself unable to meet your monthly repayments, then speak to your loan company straight away.

‘Companies have to be fair to customers because they are regulated, and if you speak to them they might be able to do something,’ says Caroline Siarkiewicz.

You can also speak to independent advisors. The Money Advice Service site (moneyadviceservice.org.uk) has plenty of free and impartial information on debt and borrowing. You could also have a confidential conversation with National Debtline, an independent charity which gives free advice by phone (0808 808 4000) and online (at nationaldebtline.org).