Debt demystified: Navigate your way through the minefield of debt

By Hayley Hemmings
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Debt can be a fact of life, but if you manage it well, it doesn’t have to become the old ball and chain you’d expect.

There have been a lot of bad words said about debt before now but really, debt should be given a fair trial. There are actually some cases where borrowing money can help propel you to a better place in your life, as opposed to leaving you living on the breadline.

In this post, you’ll find how to navigate your way through the minefield of debt types to seek out the good and give a wide berth to the bad.

Shady types of debt

1. Loan Sharks

Loan sharks are illegal lenders. They tend to prey on people who are in a pickle with money. Loan sharks may target people door-to-door and may seem friendly and helpful at first. However, they charge extortionate rates of interest – as much as 719,000% has been reported – and they often resort to threats or violence to make sure they get paid.

Conclusion – avoid like the plague. Nuff said.

 

2. Payday Loans

These are one of the worst types of legal borrowing options available. They’re designed to bridge the gap when you run out of money before payday, but they often end up turning into a nightmare, before you pay them off.

Payday loan companies charge hefty fees for borrowing small amounts. Most providers display 1000%+ APRs on their websites, which is a bit of a red flag to say the least.

As an example, a loan of £100 for one month might come with a £25 fee attached. That doesn’t sound like much, especially if you’re desperate for the cash. However, if you can’t repay on time, this is where payday loans become a disastrous slippery slope.

The worst thing you can do with a payday loan is get a new loan to pay off an old one. Do not rob Peter to pay Paul. Things can turn really bad, really quickly if you do – and it won’t do your credit rating any good. Arm yourself with more facts about payday loans here.

Conclusion – avoid if you possibly can. Try to find the money you need another way, by making some cutbacks, or picking up a part-time job. Asking a family member or friend you trust would be a better option.

 

 

 

Less risky and more useful types of debt

1. Unsecured Personal Loans

If you need to borrow up to £25K, a personal loan may be a good option to consider. Usually, it’s possible to borrow more money with a personal loan as opposed to a credit card.

Unlike secured loans (see more about these below), your assets won’t be affected if you can’t repay. However, if you can’t repay, your credit rating will definitely be affected and you may have to consider a debt management plan as a solution to your situation.

The interest rates on personal loans may be higher than what you’ll find with a secured loan, because the lender carries more risk than you will. This is especially the case, if you only want to borrow a small amount.

Conclusion – unsecured personal loans are a good option for many borrowers. If you think a personal loan might be right for you, be sure to shop around to get the best deal you can in terms of the interest rate. Avoid taking out a higher loan just to get a better interest rate though.

You can check out this article from Money Saving Expert to keep an eye on the cheapest loans around. If loan flexibility is important to you, you could also take a look at the giff gaff quick loan quote calculator.

 

2. Secured Loans

A secured loan is one that is secured against your assets – your car or home for example. Some loan providers require you to be a homeowner to apply for one. Usually secured loans are for people who want to borrow a lot of money – perhaps as much as £100K.

A secured loan does carry an element of risk, because if you can’t repay it, the lender has the right to take possession of your assets, sell them and use the proceeds to repay the debt. With that said, secured loans can come with lower interest rates attached, a benefit that will appeal to some borrowers.

Conclusion – secured loans are useful for those who need to borrow a high amount and interest rates are sometimes lower than the rates you’ll find on unsecured loans. It’s worth noting that secured loans present a higher risk for borrowers who get into problems with repayments. Check first whether you might be able to get an unsecured loan for what you need, providing you don’t need to borrow too much.

3. Credit Cards

Credit cards are a useful form of revolving credit. When you pay your credit card balance off, your credit is automatically renewed. Using credit cards can be a really smart way to manage your money for the following reasons:

You can borrow without being charged interest if you pay off your balance every month in full.

You can earn rewards or cashback, depending on which credit card you have.

If you need to buy something quickly that’s also expensive, a credit card will allow you to do so.

If you pay your credit card balance off regularly, you can build up a great credit rating.

You can easily use credit cards abroad and you get more protection when you pay by credit card, as opposed to debit card or cash.

Credit cards can become tricky beasts to handle though if you end up maxing them out. If you let your credit card debt get to the point where you have no limit left, you’ll have some big interest-loaded repayments to pay and you might find your finances are pretty tight.

Conclusion – credit cards are a smart choice for financially-savvy millennials, who like to repay their debt in full and who want to build their credit rating and earn rewards. They aren’t so good for anyone who is living beyond their means, as an open line of credit can soon lead to a large debt balance. If you’re considering a credit card & want to compare which one is right for you, head on over to our compare site.

Find out more about the benefits of making more than the minimum payments on credit cards here.

4. Mortgages

Mortgages are a type of secured loan and unless you’re super-rich, you’ll most likely need one to buy your first home. There are some great deals to be had on mortgages right now, because interest rates on both fixed and variable rate mortgages are at an all-time low. Many high street banks are offering mortgages with 2% or 3% interest rates.

Mortgages are usually offered over a 25 or 30 year term, depending on your age. You can get a mortgage over a shorter period, such as 15 years if you like, however the monthly payments will be higher.

When applying for a mortgage it’s important to consider the following:

a) How much will you really need to borrow?

When you’re borrowing money to buy a house, it’s tempting to add on a few thousand pounds to cover other costs like stamp duty or solicitor’s fees.

However doing that will most certainly cost you over time because of the interest involved, so if you can afford to pay those costs upfront, you should. Bottom line – only borrow what you absolutely need and nothing more.

b) Are there any early repayment fees?

Some lenders will require you to pay a fee if you end the mortgage early e.g. if you decide to switch to another lender after a couple of years. These fees can range between 1% and 3% of the mortgage balance, which can equate to thousands of pounds, so it’s important to know the facts on this before you sign on the dotted line.

c) Are you allowed to overpay the mortgage?

It’s good practice to do this at some point during the mortgage term if you can. Most lenders will allow you to overpay a certain amount each year, perhaps up to 10% of the mortgage balance. This is definitely a question to ask before you go ahead though.

Conclusion – mortgages are the most common type of debt that millennials will end up getting at some point. Whilst borrowing such a lot of money can be a bit nerve-wracking, this is actually a good form of debt to have because you’ll have an asset to show for it once it’s paid off – your home.

Always seek independent financial advice before getting a mortgage. You can use a website like Vouched For to find an independent mortgage advisor near you.

Top Takeaway

Not many people go through life without taking on some form of debt, especially when it comes to buying a home. If you do need to borrow money, just make sure you know what you’re getting yourself into first.

Never borrow more than you need to and always shop around to get the best loan product to suit your needs, at the lowest rate of interest.

Have you found debt to be useful before?

 

Author Bio: Hayley Hemmings is a freelance writer, blogger and tea addict from Yorkshire. She’s passionate about money matters, frugal living and loves anything handmade. When Hayley’s not writing, she’s most likely to be found enjoying snuggles with her little girl or walking her border collie through the beautiful Yorkshire countryside.  

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