Money Advice Service

Before you sign up for a credit card, bank loan or store card, or add to an existing card or loan it makes sense to think about whether you really need to borrow money. At times like this – with economic uncertainty and rising bills – many people are now choosing to pay back money they’ve already borrowed rather than borrow more.

Deciding whether you should be borrowing money

There are some very important questions you need to answer before you borrow money.

You should ask yourself if:

  • You need to spend the money
  • You have other ways of financing the purchase, and
  • You can afford to pay back the money you’re planning to borrow.

Do you really need to spend the money at all?

If you have a tendency to buy things on impulse, try giving yourself a cooling off period of at least two days. You might find you’re not so keen to buy it.

Some people who borrow money do so either without thinking if they can really afford it, because they feel they have no other option, but that often isn’t the case.

It might be that you could put off making the purchase or not make it at all.

Try asking yourself:

  • Could I wait until I can afford to buy the item without borrowing?
  • If there’s something I need, is there another way of getting it, for example, swapping it for something else, buying it second-hand or getting it for free from a free recycling website?

Can you save up or use some savings instead of borrowing money?

If you really don’t need to spend the money today, then you should seriously consider saving some money each month rather than getting into debt.

If you can wait and save up for a purchase, instead of using credit, it will cost you far less, unless you qualify for a 0% credit card deal, as you won’t have to pay any interest.

It might also have been reduced in a sale or if it’s technology, upgraded to a better model.

For example, if you wanted to buy something that cost £600:

Saving before you spend

If you don’t have any savings, but can save, for example, £50 a month, it would take you a year to save the £600 and you would have earned interest on top of this.

Cashing in savings

If you used the money from your savings account; assuming your savings earned 1.5% a year, you would lose a maximum of £9 in interest if it took you a year to save the £600 again.

That means spending £600 from your savings would ‘cost’ you a maximum of £609 by the time you’ve added in the lost interest.

Using a credit card

If you paid the £600 by credit card, charging an average interest rate of 17%, and if you paid the debt back at a rate of £50 a month, it would take you 14 months to repay the debt and would cost you £58 in interest.

That means you’d be £49 (£58-£9) worse off by paying on your credit card, rather than cashing in your savings.

Good money borrowing versus bad money borrowing

Example 1 – Sarah is a teacher who travels to work by bus each day. She gets a better job at a new school paying a higher salary, but she can’t travel there on public transport. She wants to buy a car but doesn’t have enough savings to cover the cost so she needs to borrow some money.

This is good borrowing as Sarah’s job is paying her more money.

She will recoup more than the cost of the car, including the money she borrowed.

Of course, it depends on the kind of loan she gets and how much it costs relative to her increased pay.

Example 2 – Andrew wants to trade in his old car for a new one. He thinks he’ll need to spend £5,000 to get a reasonable car. He doesn’t use his car for work but likes the freedom that having a car gives him.

He can get £500 for his old car and he can afford to pay back £86.27 a month if he borrows the rest at a rate of 5.8% APR.

It will take him five years to repay the loan and he’ll have paid a total of £5,176.20, or £5,676.20 for the car including the trade-in.

Andrew should think very carefully about taking out this loan as he’ll end up paying an extra £676.20 for his car and will have to make loan repayments for the next five years.

If his situation were to change in that time (say, his hours were reduced or he lost his job), he might not be able to keep up the repayments.

Learn more on Good debt versus bad debt.

If you do decide you want to borrow money

If you definitely want to borrow some money and you are sure you can repay it, there are a number of important factors to consider.

How much can you afford to repay?

Almost two-thirds of people clear their credit card bills in full every month. Even if you can’t pay it all off, make sure you don’t just make the minimum repayments on your credit card bill.

It’s very important to work out how much you can afford to repay each month, as this will affect which borrowing option is best for you.

Make sure you are realistic about how much you could pay if your mortgage or rent went up, if you had to spend more on things like energy bills or if your pay was cut.

Choosing the right type of credit

You should also make sure you choose the right type of credit or loan for your situation.

Otherwise, you could find yourself paying more than you need to.

Shop around and compare deals, looking at:

  • the interest rate and the APR
  • how much you will repay in total
  • any penalties for missed or late payments, and
  • the cost per week or month and whether this might vary.

Not all credit options are good or safe.

If you have a poor credit rating then you might be tempted to use a doorstep lender or a payday loan company, especially if you have few credit options.

However, these are expensive and should be avoided for anything more than a few days if possible.

Your tips for borrowing money and paying it back

Read a transcript of this video.

This article is provided by the Money Advice Service.