Sometimes borrowing a little extra is unavoidable, but it should never leave you completely out of pocket. There are some forms of credit that just aren't worth it - we name and shame the worst offenders.
We all know that however frugal and financially savvy we may be, there are some times in your life when borrowing money is necessary. However while some borrowing methods will leave you with a manageable debt to pay back, others will land you with debt that just keeps growing.
There are certain lenders out there who will prey on the vulnerable –those who are already in debt and feeling desperate, young people getting their hands on their first form of credit, or even an unsuspecting consumer. So to help you steer clear, here are the top borrowing methods you should avoid.
Sneaky store cards
In most cases store cards should be avoided altogether. Although there are ways to make them work to your advantage this is only really possible if you can be extremely disciplined and pay off your balance in full as soon as you get your statement.
Store cards bear many resemblances to credit cards in the sense that they are a form of borrowed credit that you pay back with interest – the major difference being that the vast majority of store cards charge interest at a significantly higher rate than most standard credit cards. An average store card will charge you in the region of 30% APR, which is much more than the average credit card or personal loan.
Using a store card puts you in dangerous territory because if you don’t pay your balance back in full straight away, you’ll begin to accrue more and more interest until it becomes a debt spiral that’s hard to climb out of.
Uncompetitive credit cards
Many of us will use credit cards to borrow money at one time or another. However there’s a big difference between using a credit wisely and clearing the balance every month (or better still, taking advantage of an interest free deal when you need to make a big purchase) and spending on a high-interest card without paying it back.
If you’re considering spending on a credit card make sure that you are getting a competitive deal by comparing the interest rates of cards currently on the market. If you spend on a card with a sky high interest rate and you aren't diligent about paying it back each month, you can quickly rack up much more debt than you’d bargained for.
Costly cash on credit
Another thing best avoided when using a credit card is withdrawing cash on credit. It may seem like a quick and easy way to get your hands on cash, but it will cost you so dearly that it’s really not worth doing. First, the interest rate charged on a cash advance will be more expensive than your card’s standard rate – often you’ll be paying up to 30% APR on however much you withdraw.
As well as the lofty interest rate, you’re also likely to be charged a fee for withdrawing cash with your credit card. This will either be a percentage of however much you withdraw, or a flat charge. What’s more, any interest-free period on your credit card won’t apply to cash advances, so you’ll start accumulating interest on your withdrawn cash straight away.
Finally, because of the negative order of repayment applied to most credit cards, your cash advance is likely to be the last thing paid off as it is likely to be the most expensive – meaning it will sit at the back of the queue accruing more and more interest until you can get to it.
The perils of payday loans
A payday loan is a type of loan that arguably targets those who are struggling to stretch their finances from month to month and so are likely to be in some debt already. They offer to alleviate all your money worries by giving you a one-off loan to tide you over until your next payday, at which point you pay the money back with your wages. This can be extremely tempting if you’re running short of money but still have a couple of weeks until payday.
So what’s the catch? The main one is that payday loans come with interest rates to make you shudder – often in the region of 1000% APR (making store cards’ 30% look almost reasonable!). This can be equivalent to a £25 charge for every £100 loaned, and so is really not a cost-effective way to borrow.
Though they’ll give you enough cash until payday, you’ll then be paying a huge amount back to the loan company for the privilege. Even worse, it can be tempting to roll your loan over to next month which is when your debt will really start to spiral out of control. As such, payday loans are best avoided if you can at all help it.
‘Dodgy’ lenders
Also known as loan sharks, these lenders are unauthorised and as such they aren’t regulated by any licensed body. If you borrow money from a ‘dodgy’ lender you’re likely to be charged extortionate rates of interest and may receive threats and harassment if you fail to repay on time. As such it goes without saying that you should never see this as a borrowing option.
You can find out whether or not a lender is authorised and legal by checking if they are licensed by the Office of Fair Trading.
What’s my alternative?
There are many perfectly legal and even cost-effective ways to borrow when you need to:
- Use an authorised overdraft. If you need a little extra to tide you over, don’t dip below zero (or over an existing overdraft limit) without informing your bank as this will result in charges as well as high interest rates. Your bank is likely to grant a request for a short-term extension of your overdraft, and while this may still cost you in terms of interest, it will be a much more cost-effective option than those listed above.
- If you are using a store card or credit card, pay it off in full as soon as you get your statement. This is the only way to avoid hefty interest charges and to stay on top of your borrowing.
- If you need to finance a special occasion or require emergency funds, and have no other alternative but to borrow, consider getting a competitive personal loan rather than heading down the slippery slope of payday loans and extortionate lenders.
Finally, though it’s easier said than done, don’t spend beyond your means and you won’t need to borrow. If you’re struggling to stretch your income from month to month draw up a budget to help you take control and rein in unnecessary spending. If you do find that borrowing is your only alternative, just make sure you’re not getting caught out and end up owing more than you have to.
