The range of loan options available to borrowers has never been more varied. But with each method catering for different needs and some harbouring nasty surprises – such as 4,000% interest rates – it's important to find the right loan for the right purpose. Here, we run through the best and worst ways to borrow, starting with the baddies.
Payday loans Payday loans need little introduction. In theory, a quick cash loan to cover unforeseen, emergency expenditure is perfectly viable. Generally, payday lenders – the likes of Wonga, QuickQuid and GetSomeDosh – offer quick and easy unsecured loans of up to £1,000 over 30 days. But in return for easy money, annual percentage rates (APRs) of interest can stretch into the thousands.
While lenders argue emphasis on the high APR is a misrepresentation as the money is not lent over a year, critics say the loans target the most financially vulnerable, whose debts can easily snowball out of control. In March, a report by the Office of Fair Trading found payday lenders make the majority of their money from missed repayment fees and interest accrued.
It also found aggressive debt collection methods and a failure to carry out thorough affordability assessments. It issued the 50 companies involved an ultimatum – shape up or lose your licence.
Tim Moss, moneysupermarket.com's head of loans, says: "Payday loans should be used as emergency money and nothing else. But be extra wary of companies that charge the same to borrow for eight days as they would do for 30." Guarantor loans Another blossoming sector of the short-term loan market is guarantor loans. Aimed at people with poor credit records and young people without a credit history, guarantor loans normally offer a way of borrowing up to £7,500 over one to five years, with a second borrower guaranteeing the loan.
Amigo is a typical provider, with an APR of 49.9% but it does not charge any fees. James Benamor, Amigo's chief executive, says: "It's an alternative to borrowing money from your family and friends." However, Moss points out that while lenders have double the security of a normal loan, the borrower risks the demise of personal relations with their guarantor should they struggle to keep up with repayments.
Credit unions A third option to consider is credit unions. Member-owned and not-for-profit credit unions can offer competitive rates on small loans. By law, they cannot charge more than 2% a month interest or 26.8% APR.
Loan security As the name suggests, secured loans use your home – or sometimes your car – as security. Secured loans can lend sums of up to £250,000 but it depends on the value of your home – generally, the maximum loan-to-value (LTV) ratio is 90% but 70% is usually the norm.
The loans can be relatively easy to obtain since lenders are comfortable with the security of your property. Effectively a second mortgage, it can take time to organise since your house will need to be valued. The timescale of the loan can extend to around 20 years, with APRs hovering around 6% to 15%.
Failure to keep up repayments could result in your home being repossessed and sold to cover your debt.
Paul Crayston, a spokesperson for National Debtline, says: "You have to be absolutely certain you can make the repayments as you could lose your house. I would go as far to say do not take a secured loan without first seeking free, impartial advice." It's normally better to opt for an unsecured loan instead. APRs on personal loans are currently very competitive, with Derbyshire Building Society offering a 5.1% rate on loans between £7,500 and £14,999, with lots of other providers not far behind.
On the face of it, this is one of the best ways to borrow but there's no guarantee you will be able to secure such a tantalising rate as banks will take your credit history into account.
Despite the negative connotations attached to overdrafts, they can be a very effective way of managing a loan. However, it is vital to distinguish between unauthorised and authorised overdrafts. "Unauthorised overdrafts can be the most expensive way to borrow money and you should do whatever you can do avoid slipping into one," says Crayston.
The fees and charges can equate to more than 2,000% APR, with daily penalties often putting a return to the black out of reach. However, authorised overdrafts arranged in advance can sometimes be interest-free up to a certain amount (First Direct, for example, offers current account holders a £250 interest-free overdraft) but more generally they provide a comfortable buffer for borrowers.
Competitive rates normally tickle 16% and so should only be used as short-term fixes. For example, as of 8 March, top of Moneyfacts' best-buy overdraft table was the Citibank Plus Current with an authorised rate of 16.9% (based on a £500 overdraft).
Interest-free credit And so we arrive at the cheapest way to borrow money – interest-free credit cards. The best deals tend to offer 0% on purchases and balance transfers for anything up to 24 months, although a 2 to 3% balance transfer fee is likely.
For example, Barclaycard is offering 25 months at 0% on balance transfers, with a 2.9% fee, and six months' interest free on purchases – though the interest rate on purchases leaps to 18.9% APR once the 25 months is up. For a longer period for 0% on purchases, the Halifax Purchase Credit Card is interest-free for 17 months (based on a £1,200 credit limit).
Such cards are great for big purchases where you can pay off a lump sum over a number of months and not worry about it accruing interest. Similarly, balance transfers allow you to consolidate your debts cheaply and pay off more expensive loans. However, it's important to know that 0% on balance transfers doesn't necessarily mean 0% on purchases.
Whatever way you borrow money, remember they can all turn bad if you fail to manage your debt responsibly.
Top three borrowing mistakes 1. Pushing it to the max – exceed an authorised overdraft and you will be charged daily and maxing out your credit card will be seen as a sign of financial stress.
2. Beating your credit into the ground – if you have been refused credit, don't keep applying to different providers as each rejection will leave a further mark on your lending history.
3. Forgetting about fees – many loans come with any number of fees and charges, so make sure you know what they are before you commit.