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Ten things you need to know to avoid bad debt
Debt is like fire - used well, it's a fantastic tool, used badly, it burns. That’s why of all elements of finance, it’s the one that needs the most careful handling. Yet for those in the know, it's possible to borrow without any cost whatsoever.
Here are my 10 need-to-knows:
1. Is borrowing right for you?
Debt isn't bad, bad debt is bad. So think carefully whether you really need it. Can you save up instead or use existing savings? Some will yell “neither a borrower nor a lender be”, but life isn’t clear-cut. Some people make planned purchases, for example, they’ve got a new job far from public transport, so need a loan for a car. Provided the loan and interest are minimised, and the repayments budgeted, it can be an enabling choice. Yet if you borrow willy-nilly to fill shortfalls in your monthly income, that’s usually a nightmare.
2. 18 months’ interest-free borrowing
If you've a big purchase that can be paid by credit card, and can repay within 18 months, you can borrow totally interest-free with a 0% deal. Only do this if you’re sure you can fully clear before the 0% ends and make the minimum repayment each month (or you lose the 0% deal).
The market's longest deals are for new cardholders at Tescobank.com and Santander.co.uk at 18 months 0% (18.9% rep APR after), though Tesco’s advantage is it also gives reward points. If you need longer, MBNA has a card that’s 6.9% until repaid on all purchases within 90 days (after that, they’re 16.9% rep APR).
The real key's whether you’ll be accepted. The way to find out is to apply, but that leaves a mark on your credit file. So use my Eligibility Checker at www.mse.me/eligibility, which shows cards are most likely to accept you.
3. Cheapest loans 4.5% APR
If you can't pay on a credit card, need longer, need more or prefer the disciplined structure of fixed repayments, then the straightforward option's a personal loan. Rates change daily – the best at time of writing are below. Updated list at www.mse.me/loans.
- Loans £7.5k-£15k: www.santander-products.co.uk is 4.5% representative APR.
- Loans £5k-£7.5k: www.sainsburysbank.co.uk is 5.7% rep APR.
- Loans £3k-£5k: www.sainsburysbank.co.uk is 12.4% rep APR - Under £3k: There are no cheap loans – see points 4 and 5 below.
Remember, these 'representative APR' loans mean only 51% of accepted applicants must get the advertised rate. Others can pay more.
4. 29-month 0% 'loan' for a 4% fee
Buying something you can pay for on a card, or want a cheaper loan for smaller amounts? A few specialist credit cards allow accepted new customers cheap 'money transfers'. This means the card pays money directly to your bank account (that you can spend), so you owe it instead. Mbna.co.uk is 29 months 0% for a 4% fee and www.Fluid.co.uk is 28 months with 4% fee. More help at www.mse.me/moneytransfers.
Always pay at least the minimum monthly repayment and schedule repayments to clear the card by the time the 0% ends, or you’ll pay a big 22.9% rep APR.
5. Peer-to-peer loans
Try to repay most loans early and you're charged penalties, but there's a penalty-free alternative. Peer-to-peer lending sites match people who want to borrow with those who have cash to lend.
The rate you get depends on your credit score, but unlike normal loans, you can check without it marking your file. The two biggies are www.zopa.com and www.ratesetter.com, which can be about 9% APR on £2,500 for good credit scorers compared to cheapest standard loans at 14.9% rep APR. Full help at www.mse.me/peertopeer.
6. Length counts
Many people focus just on the interest rate. If you borrow longer, the interest is added year after year. So the shorter you borrow for, the better. Those who shift credit card debts onto their mortgage should consider this – 18% repaid over three years is cheaper than 5% repaid over 20.
7. In hardship? Are you eligible for a Government 0% loan?
If you're desperate, these interest-free loans are far better than payday loans. There's no credit check, though they will check you can repay.
- Local council support schemes: Previously called 'crisis loans', these are administered locally, so sadly whether you can get one is a postcode lottery. They're for those with no savings in emergencies.
- Budgeting loans: If you're on some income-based benefits, you could be eligible for a loan of up to £1,500 to help you meet essential living costs. Apply online at Gov.uk/budgeting-loans or via local Jobcentres.
8. Try local credit unions
If you're looking for smaller loans, check if there's a credit union near you. These are small savings and loans mutuals, helping local communities. They usually lend from £50 to £3,000, with APRs usually about 13%, but can be higher. Locate ones near you at Findyourcreditunion.co.uk.
9. Set up a direct debit to protect your credit score
Forget or make late repayments and you risk a fine, losing your 0% deal, and a black mark on your file. An easy tip's to set up a direct debit to cover at least the monthly minimum, then pay more on top manually.
10. Debt to avoid
While I’m never gung-ho about borrowing, some debt is better than others. Particularly dangerous types include high cost credit (including payday loans). With APRs up to 6,000%, these are the loans to avoid.
Store cards are the devil's debt. These are credit cards locked to one store, but with higher 25%+ APRs. If there's a decent discount, use it, but pay it off IN FULL each month.
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