Beginner’s guide to borrowing money

For those of us who have never borrowed money before, the world of credit can be very confusing. That’s why we created this complete beginner’s guide to borrowing money; to help you out by making it easier to understand. Let’s dig in.


Why borrow money?

Rather than waiting a long time to make a purchase by saving up the money you will need to buy it upfront, borrowing money (or ‘arranging credit’) gives you a way to buy it sooner than you could otherwise by paying for it with someone else’s money.

Borrowing money comes with a cost. This is usually charged in interest rates, though there can also be arrangement fees and/or other further charges. What this means is that borrowing money is a more expensive way to pay for something in the long run than paying for it out of savings would be.

When an agreement is reached between a lender (like a bank) and a borrower (like me or you) over an amount of money that can be borrowed, in what way (i.e. lump sum or instalments etc.) and on what repayment terms (i.e. interest rates and frequency of repayments etc.) — this is referred to as a credit agreement.


Should you borrow money?

Debt is neither good nor bad. And while not having debts to pay off affords you a certain level of freedom and flexibility in managing your income, there are big purchases in life where if you saved up enough to buy the thing outright, it would make doing so a lot harder. Sometimes impossibly so.

One example is buying a house. Average house prices in the UK are now £316,000 in England, £220,000 in Wales, £195,000 in Scotland and £169,000 in Northern Ireland. So for most people, saving up enough cash to buy a house outright might take most of their lives. Making a mortgage a better option for buying a property. Just remember that with any financial decision or arrangement, it’s important to know what you’re doing with your money and to be on top of managing it.

 

Ways to borrow money

There are lots of ways to borrow money. Here’s a quick summary of some of the main ways.

 

Loan

Loans are the best option for borrowing when you’re looking to fund a bigger one-off purchase like a car.

Credit card

You can use credit cards in lots of ways, be that for regular everyday spending, bigger one-off purchases like a holiday, balance or money transfers. Some credit cards also offer incentives like cashback or other rewards.

However, credit cards are better thought of as spending tools, rather than borrowing tools. Borrowing on credit cards (when you spend and don’t pay off the balance in the same month) is usually a very expensive way of borrowing.

Mortgage

A mortgage is a loan specifically for purchasing property or land. Compared to other types of loans and credit agreements, mortgages tend to let you take on debt at more affordable rates. This debt makes sense for many people because otherwise owning a home might not be possible… at least not for a really, really long time anyway.

 

Overdraft

An overdraft is an option often used for short term borrowing. Particularly in situations when money is needed quickly for things like unexpected bills and everyday spending.

 

How much can I borrow?

How much money you’re able to borrow will depend on your financial situation and the lender’s risk appetite. When reviewing your financial situation lenders may look at: how much you earn, your lifestyle and expenses, how much debt you have, your credit history and a number of other things. They will use this information to check that you meet their eligibility criteria and to calculate what repayments you can afford, otherwise known as your affordability.

A lender’s appetite for risk depends upon what’s currently going on in the world and the financial markets. During times of economic uncertainty lenders worry about whether the people they’re lending money to will become less able to pay them back (whether this is because they’ve lost their job or because of rising prices).

 

How to borrow money

Borrowing money to finance a purchase isn’t a decision that should be made lightly. Paying it back over time is a big commitment, after all. But if after thinking about it long and hard, you’ve decided this is the best option for you, here’s what to do next:

 

1. Check your credit reports

When gearing up to arrange credit, an important starting place is checking your credit reports. Your credit reports contain many things but lenders are particularly interested in the overview it gives of your historic experiences in borrowing money and your track record in paying it back (i.e. did you make payments in full and on time).

If you’ve never borrowed money before this can cause a problem for you as you may be regarded as ‘thin file’. Which literally means that there is little data within your credit report.

This creates an issue when you go to apply for credit as lenders, when reviewing your credit history, are unable to judge how reliable you’ll be in paying it back. Essentially without a track record, how you handle credit is an unknown factor. In the eyes of lenders this means that you’re a higher risk. Consequently, you may find it challenging to get approved for credit, or if you are, that you are offered high interest rates on financial products reflecting this perceived risk.

 

Another important thing to consider is that when you submit an application to borrow money, and the lender checks your credit report, this leaves a mark. It’s referred to as a ‘hard check’ and too many of these in a six-month period is considered a bad thing by lenders, and so it causes your credit score to go down.

 

This is why it’s wise to look at your credit reports ahead of applying for credit to consider how likely you are to be approved. If your credit score suggests it’s unlikely, you might think about improving your chances first, then applying. Loqbox is the easy way to build your credit score. 

 

Checking your credit reports also gives you the opportunity to check that all the information on your credit reports is accurate and up to date. If not, be aware that incorrect information may damage your chances of getting approved for credit. So it’s best to take steps to correct any mistakes you find.

 

There are three main credit reference agencies in the UK — Experian, Equifax and TransUnion. And each holds a separate credit report on you. So it’s important to check all three. It's free to check your credit reports online. Try it now using the following services:

 

 

2. Shop around to find the best deal for you

Use comparison sites like MoneySuperMarket* to get quotes and compare offers tailored to your needs. However, bear in mind that sometimes it can be cheaper to go to lenders directly.

Annual percentage rate (APR) represents the overall cost of borrowing money to you. Different products, and lenders, offer different APRs. So you want to find the deal with the lowest APR. Also note that people with good credit scores will generally be offered better deals.


* Just to be super transparent if you sign up and follow these links although it's free for you, Loqbox may get a small referral fee from ClearScore and MoneySuperMarket.


Find out more about APR in our video here:


Improvements to your credit score are not guaranteed

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