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Eastbourne Citizens Advice BureauFinancial Literacy

BORROWING

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Many of us will need to borrow money sometimes and there are several ways to do this – some ways cost a lot more than others.

In this unit we will look at how borrowing money works in various forms including:

• Loans

• Overdrafts

• Credit cards

• Credit agreements

• Interest free credit

• Store Cards

• Hire purchase

• Consolidation loans

• Mortgages

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You could borrow money from a friend or family member, in which case the arrangements for paying the money back are entirely up to you.

Although friends and family are less likely to charge you interest and will probably be more flexible with repayment, borrowing money from people close to you can sometimes put a strain on your relationship.

In comparison, borrowing from a bank or building society is a business transaction with clearly defined rules to follow.

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Fact:In April 2013 the Bank of England

announced that the amount of money borrowed by UK consumers had reached

1.4 trillion pounds.

That’s:1.4 million million pounds

In the years 2011-2012 Citizens Advice has seen a 23% increase in the number of people seeking help for debt problems

from the previous year

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LOANS

When you borrow money from a bank or other lender you enter into a contract with them which governs the repayment.

You have to be 18 years old to be able to enter into such a contract.

Say, for example you arrange to borrow £1000 from a bank:

The bank will offer you a period of time over which you can repay the money usually stated in months eg. 12, 18, 24 months etc.

The bank will tell you what their interest rate is stated as Annual Percentage Rate or APR.

They will tell you how much interest is charged per month and how much your monthly repayments will be.

They should also total these figures up so you can see how much you are paying in total.

You will also agree the means of payment e.g. standing order, cash payments, cheques etc and the date each month when you must pay.

Lets look at some examples:

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You want to borrow £1000 as a loan and you compare the price of repayments over 12 months, 18 months and 24 months.

The interest rate is 17.8% APR

The bank give you the following figures:

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Loan amount: £ 1000.00 Typical APR: 17.8 %Term: 12 months Initial repayment: £ 90.91 Subsequent monthly repayments: £ 90.97 Total amount repayable: £ 1091.58

Loan amount: £ 1000.00 Typical APR: 17.8 %Term: 18 months Initial repayment: £ 62.93 Subsequent monthly repayments: £ 63.10 Total amount repayable: £ 1135.63

Loan amount: £ 1000.00 Typical APR: 17.8 %Term: 24 months Initial repayment: £ 49.18 Subsequent monthly repayments: £ 49.20 Total amount repayable: £ 1180.78

These figures are example only

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Loan amount: £ 1000.00 Typical APR: 17.8 %Term: 12 months Initial repayment: £ 90.91 Subsequent monthly repayments: £ 90.97 Total amount repayable: £ 1091.58

Loan amount: £ 1000.00 Typical APR: 17.8 % Term: 18 months Initial repayment: £ 62.93 Subsequent monthly repayments: £ 63.10 Total amount repayable: £ 1135.63

Loan amount: £ 1000.00 Typical APR: 17.8 %Term: 24 monthsInitial repayment: £ 49.18 Subsequent monthly repayments: £ 49.20 Total amount repayable: £ 1180.78

These figures are example only

As you can see from these

figures, although the monthly

repayments are lower, you end up paying more to borrow the

same amount of money over a

longer period of time

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The Annual Percentage Rate of the total charge for credit (APR) is a standard way of measuring the real cost of credit to the customer, expressed as an annual rate. The APR is different to a flat rate of interest and more accurately reflects the true cost.

The formula for calculating the APR is very complex, but basically the interest and all other charges made for granting the credit (the total charge for credit) are totalled and then expressed as an annual rate.

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Payment Protection Insurance

When you borrow money most lenders will offer you a form of payment protection insurance. This gives you protection in case you are suddenly unable to pay, for example due to ill health, an accident or loss of a job.

It can cover car finance, personal loans, credit cards and store cards, catalogue debts and mortgages

An amount for insurance is added to your monthly repayment.

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PPI can be very expensive and it may not be suitable for you or you may have other ways to cover the repayments if you need to, so stop and think about whether you really need it before you agree to take it out

Always check the terms and conditions of the policy very carefully. There will often be lots of exclusions, which means there may be lots of circumstances where you won't be covered if you want to make a claim

If you have a loan which includes PPI and you feel you were mis-sold this product, you may be able to get a refund.

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Payment protection insurance is normally optional but some credit arrangements make it compulsory.

Most payment protection insurance agreements pay only a part of the balance each month, for a limited period. The most common amount paid is 10% for ten months.

The amount paid off is always equal to or more than the minimum monthly payment required by the credit card or store card company.

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If you are sick, lose your job and become unable to make your monthly payments and you have Payment Protection cover you should contact the lender and make a claim as soon as possible.

Check the details of your credit agreement for further information.

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OVERDRAFTS

Overdraft is an agreement with your bank to take out more money from your current account than it currently contains.

For example, if you have an overdraft limit of £200 on your account you can spend all the money you have in the account plus another £200.

An overdraft can be a good way to borrow money short-term or to have some funds available to cover emergencies.

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For example: you need £800 to put a deposit on a flat. At present you only have £600 in your account and your pay goes into your bank account in two weeks time.

You arrange an overdraft of £300 with your bank.

You write a cheque for £800 for the deposit.

When the cheque is cashed your account shows a balance of - £200. This gives you up to £100 to live on until your wages go into your account.

You spend an extra £75.

Your wages of £900 go into your account

What does your account balance show now?

Click to show the answer

Account balance

£600

-£200

-£275

?

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For example: you need £800 to put a deposit on a flat. At present you only have £600 in your account and your pay goes into your bank account in two weeks time.

You arrange an overdraft of £300 with your bank.

You write a cheque for £800 for the deposit.

When the cheque is cashed your account shows a balance of - £200. This gives you up to £100 to live on until your wages go into your account.

You spend an extra £75.

Your wages of £900 go into your account

What does your account balance show now?

Answer = When your wages are paid in, your account balance is £625 minus any interest charges. Many student accounts do not charge interest on overdrafts.

Account balance

£600

-£200

-£275

£625

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This is a copy of the terms and conditions for a typical overdraft for a current account.

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The interest rate is shown as 1.36%

per month

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Interest rate 1.36% per month.

In our example you were overdrawn by £275

Your wages of £900 were paid into your account.

Therefore you would be charged £3.74 interest for the first month.

The balance minus interest charges after one month would be:

Account balance

-£275

+£900

£625

Interest charge

-£3.74

£621.26

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How much would the charges be if you remained overdrawn by £275 for 6 months?

Answer

£275 x 1.36% = £3.74 x 6 = £22.44

assuming no other transactions were made on this account.

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The terms and conditions also

show what happens if you were to

exceed the agreed overdraft limit

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CREDIT CARDS

Credit Cards give you a separate account from which you can borrow money. You can use the card to pay for goods or services in shops, by phone or via the internet.

When you first obtain a credit card you will have a credit limit. This is the amount of money you can borrow.

Each month you will be sent a statement which shows:

• Each item of spending

• The total balance

• The interest charged

• The minimum amount you can repay this month, usually 5% of the total balance

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This is a credit card statement from a high street lender. Most statements are sent out monthly.

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Here you can see:

• the amount left over from the previous month. The

amount paid since the last statement

•The amount spent with the card since the last

statement

•The current balance

•The minimum payment due

Please note the small print

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A second sheet shows the transactions and charges on the account since the last statement.

Here you can see:

The balance from the previous statement = £177.74

The amount paid into the account since the last statement = £50

Payment protection insurance = £1.00

Interest on the balance = £2.42

So: £177.74 minus £50 = £127.74 plus £3.42 charges this month =

£131.16 left to pay

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If you pay off the current balance within one month you pay no interest on what you borrow. This way using a credit card to pay for things can become a handy alternative to using cash.

For example:

Your current balance is zero.

You buy a jacket for £50 on 12th March.

You receive your credit card statement on 20th March and the balance shows £50. The minimum payment is £5 to reach your account by 2nd April

You pay £50 on the 22nd March

No interest charge.

Balance now zero.

If you paid only the minimum amount of £5 you would incur interest charges on the remaining £45. If the interest rate is 1.36% per month how much would your total balance be next month? Click to see the answer

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If you pay off the current balance within one month you pay no interest on what you borrow. This way using a credit card to pay for things can become a handy alternative to using cash.

For example:

Your current balance is zero.

You buy a jacket for £50 on 12th March.

You receive your credit card statement on 20th March and the balance shows £50. The minimum payment is £5 to reach your account by 2nd April

You pay £50 on the 22nd March

No interest charge.

Balance now zero.

If you paid only the minimum amount of £5 you would incur interest charges on the remaining £45. If the interest rate is 1.36% per month how much would your total balance be next month? Click to see the answer

£45 x 1.36% = £0.61 interest total balance = £45.61

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In this example if you continued to pay only the minimum amount of £5 each month how long would it take to pay for the jacket priced £50?

Click to see the answer

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In this example if you continued to pay only the minimum amount of £5 each month how long would it take to pay for the jacket priced £50?

It would take 10 months to pay off the balance and you would be charged £3.33 total interest.

Total cost £53.33

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Charge cardsThe difference between a charge card and a credit card is that the amount borrowed on a charge card must be repaid in full at the end of a given period, usually a month. Interest is not charged on the amount but you may have to pay an annual fee for the card.

American Express and Diners Club are the two major operators.

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Credit agreements

Under credit sale, you buy the goods at the cash price.

You usually have to pay interest but some lenders offer interest-free credit. Repayment is made in instalments. You are the legal owner of the goods as soon as the contract is made and the goods cannot be returned if you change your mind. The supplier cannot repossess the goods if you fall behind in repayments but can take court action to recover the money owed if you don’t keep up the repayments.

Credit sale agreements are now more common than hire purchase agreements and it is important not to confuse the two.

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Interest free credit

This is potentially a good way to purchase goods though it is not often available. You do not pay any more than the cash price but have a period of time to pay for what you’ve bought.

Read the small print carefully. Sometimes a way of paying called ‘9 months interest free option’ is offered which is very different from ‘interest free credit’.

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Here is an example of an interest free credit offer from one high street electrical retailer:

Cash Price £699.99. No deposit required. Either pay £699.99 within 10 months of the date of purchase, total amount payable £699.99, no interest charges paid. Or 39 monthly payments of £32.57 commencing 10 months after the purchase date. Total amount payable £1270.23. 29.5% typical APR. Interest calculated from date of agreement.

Buy Now Pay Later on everything over £299

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Here is an example from a catalogue retail store:

Typical example. Spend £195 on a 6 month Buy Now Pay Later agreement on your Store Card. Pay nothing for 6 months (although you can if you wish) and then settle the cash price at that point. Total payable £195.

Or choose to spread the cost over a longer period, paying a minimum 3% or £2 each month (whichever is the greater) and if you only ever pay the minimum the total payable would be £524.36 (25.9% APR). Includes deferred interest from the Buy Now Pay Later period.

Typical example. Spend £195 on a 6 month Buy Now Pay Later agreement on your Store Card. Pay nothing for 6 months (although you can if you wish) and then settle the cash price at that point. Total payable £195.

Or choose to spread the cost over a longer period, paying a minimum 3% or £2 each month (whichever is the greater) and if you only ever pay the minimum the total payable would be £524.36 (25.9% APR). Includes deferred interest from the Buy Now Pay Later period.

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As you can see from these examples Interest Free Credit can be a good deal if you pay the full amount after the free period.

If you don’t pay the full amount in time you could end up paying more than twice as much for the item.

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Store CardsStore cards are the cards that many major retailers offer their customers as a convenient way of buying goods in their stores, often with incentives attached such as special discount and privileges.

A store card generally• Is considered as another payment method amongst others such as cash, credit cards etc • Has a lower credit limit than a credit card, and • Can be used only at the issuing retailer store

Store cards operate similarly to a credit card with a monthly statement being sent to all customers with the requirement to pay off at least the minimum payment. When considering a store card, you need to weigh up the costs and benefits in the same way as you would for other forms of credit.

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Store cards - tips Before signing up for a store card consider the following:• Do you really need a store card?• Do you have other ways to get credit such as credit cards or an overdraft?• If so which has the lowest interest rate?• Discounts sound tempting – only if you pay off the full balance• Is there is an interest-free period? If so how much will the interest be when it ends?• Check all terms of the agreement - APR, interest free period, penalties for default and late payment• If Payment protection Insurance is offered is it worth having? Read the terms and conditions• Beware of persistent shop assistants who try to persuade you to sign up for a card. • Don’t be rushed into it. If in doubt take the paperwork home and read it before signing anything.

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Hire purchase (HP)

Under a hire purchase (HP) agreement, you hire goods until you pay the final instalment. You will not own the goods until then.

This means that you can end the agreement and return the goods at any time. However, you will owe any overdue instalments and, if less than half of the total price has been paid, you may also have to pay the difference.

The company which has made the loan (the lender) may be able to take back (repossess) the goods if, for example, you fall behind with payments. The lender does not have to sell the repossessed goods to reduce your debt.

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Advantages Disadvantages Conclusion

Allows you to buy more expensive items on credit

It may be easier to get a Hire Purchase agreement than a bank loan or credit card

You do not own the goods until you have paid off the full amount.

The Hire Purchase company can take back the goods if you do not keep up with payments.

If the goods are taken back you may still owe money on them.

HP can be more expensive than a loan or a credit card.

You can return the goods and end the agreement any time as long as you are up to date with your payments.

Its worth considering other forms of credit first.

Hire purchase

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Mail order

Mail order shopping is usually arranged through a catalogue and is normally interest free, the customer paying only the price of the purchase in instalments. However, goods bought in this way may be more expensive.

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Advantages Disadvantages Conclusion

Small weekly repayments

It might be easier to get catalogue credit than from other lenders

Only borrow the price of goods you buy

Catalogues may be more expensive

Can be higher interest rates

Compare with prices in shops before buying,

Compare interest rates with other forms of borrowing before buying.

Mail Order catalogue goods on credit

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Doorstep sellers

Selling or promoting goods or services on credit by calling at people’s

homes is illegal unless the company has a licence to sell credit outside trade

premises. Common examples are double glazing or home improvements.

Any agreement that is made illegally may not be enforceable.

It is a criminal offence to try to make a cash loan outside trade premises

unless the visit is made to your home in response to a written and signed

request. Any agreement that is made illegally may not be enforceable.

If you have signed an agreement of this type seek advice.

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Credit unions A credit union is a self-help co-operative whose members pool their savings to provide each other with credit at a low interest rate. If a member fails to repay a loan, the credit union can seek repayment through the courts.

Credit unions encourage people to save what they can and only borrow as much as they can afford. After you have been saving with the credit union for a few months you can apply for a loan.

The maximum interest charge is 2% per month.

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Pawnbrokers

Pawnbrokers lend money against the value of property left with them.

They must give a receipt known as a ticket. Pawnbrokers agree to

keep the property for at least six months but you can get it back at any

time during that period by paying off the loan plus interest. The period

can be extended by paying the interest only and re-pledging the

property.

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Loan sharks

lend money to people who are usually unable to borrow from other

sources. They charge very high interest and are not concerned by

your ability to repay. They may force you to take out a second loan

to repay the first.

If you get behind with payments a loan shark may threaten you.

This is illegal and you

If you have entered into an agreement with a loan shark or an

agreement with excessively high interest you should seek advice.

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Payday Loans

Payday loans are short-term loans for small amounts of money.

They are available from high street shops and internet sites.

Payday loans can be easy to get but interest rates are very high.

There may be other ways for you to sort out your short-term money problem so think about the alternatives before you borrow.

If you are having problems paying back the loan the lender may offer you longer to pay. This is known as a loan extension or deferral. Beware of doing this. If you extend the loan you will have to pay more interest and there may be extra fees.

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Consolidation Loans

A consolidation loan is a loan to pay off all your existing debts from whatever source such as credit cards, loans, overdrafts etc.

From then on you only make repayments to the new creditor. The advantage of this is only one payment to remember.

The disadvantages can be higher interest rates and consequences if you do not make payments on time.

Consolidation loans are usually secured against your home and therefore are only available to home owners. If you fail to keep up the payments you could lose your home.

You should think carefully before taking out a consolidation loan. There may be better, cheaper ways to pay off your existing debts.

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Mortgages

If you wish to buy a home you may be able to borrow money to do this.  This is called a mortgage. The loan is for a fixed period usually 25 years and you have to pay interest on the loan. If you do not keep up the agreed repayments, the lender can take possession of your home.

Mortgages are available from banks and building societies and also other lenders. This is a very competitive area and the lenders are constantly changing the types of mortgage they offer. Because of this it is not possible to cover this subject in detail here. 

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There are several types of mortgage available. The most common are:-There are two main types of mortgage: 

repayment mortgage, where your regular repayment goes towards the amount you borrowed (the capital) and the interest so that the whole loan is paid off by the end of the mortgage

 interest only mortgage, where your regular repayment goes towards the interest only. At the end of the mortgage you repay the capital in a lump sum. Usually this will be from savings or an insurance policy you took out at the same time as the mortgage. For example, an endowment or pension.

Islamic mortgage. This is a mortgage in which none of the monthly payments includes interest. Instead, the lender makes a charge for lending you the capital to buy your property which can be recovered in one of a number of different ways, for example, by charging you rent.

 The cost of the mortgage depends on the interest rate. There are lots of different types of interest rates such as fixed rate or variable rate. It's worth taking some time to compare types and decide what suits you best.

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Before borrowing money you should consider the full cost of paying it back and how this will affect your budget. Can you afford the repayments over a period of time?

You should compare interest rates and opt for the lowest.

Borrowing money can mean you can buy things now rather than having to wait to save up the same amount of money. Do you really need to buy it sooner rather than later?

With so many people getting into problems as a result of borrowing money do you want to be another part of this growing statistic?

Do you know what the consequences can be of borrowing money and getting into debt?

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People get into debt for a variety of reasons and it is not always their fault. Sometimes wreckless spending or bad budgeting is the cause of debt. Sometimes its just bad luck and unexpected change of circumstances. Debt is something that can affect anyone at anytime.

If you find you are having trouble meeting your payments don’t panic and don’t ignore the problem.

Get to grips with your finances, review your budget and take action before it gets out of control.

Contact lenders and tell them about the problem.

If in doubt seek advice.