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By Julia Kukiewicz
Editor
8 September 2009
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The Golden Rules
Whether you borrow with a loan or credit card keep these golden rules in mind:
- Don't borrow if you could save instead.
- Borrow as little as you can for the shortest amount of time you can.
- Try to avoid secured loans.
- Use one credit card for one job.
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TAKING out a loan or credit card is a simple way to borrow money.
However, it's no secret that the path to model borrowing behaviour is by no means a straight one.
Interest payments, confusing products and unfamiliar terms have been known to trip up even the most financially-savvy on occasion. But finding the best credit card or loan for your needs and avoiding the pitfalls needn't be complicated.
By answering a few simple questions you can find the best way to borrow.
Why do you need to borrow?
Before you even start comparing credit card or loan deals you'll need to ask yourself why you need to borrow this money.
It sounds obvious but saving up for a holiday or making home improvements will usually be cheaper (and always much safer) than borrowing with a credit card or loan.
Taking on debt unnecessarily should always be avoided. Consider putting off your spending plans and opening a savings account or separate current account instead and putting money away.
This also applies to using borrowing to supplement your income. Credit cards and loans are best suited for borrowing one amount, one time which you can budget for and avoid overspending or making unchecked interest payments on (the exception is very short-term borrowing which suits reward credit cards)
If that's why you need to borrow then it's probably for one of the following reasons...
1. To Make Existing Debts Cheaper
A new loan or credit card can sometimes help you to reduce your existing interest payments.
However, moving your balance from one product to another doesn't come for free.
This is particularly true if you have a balance on a credit card or a number of credit cards and are struggling to repay the interest. Transferring the balance onto a balance transfer credit card with a 0% rate or a low life-of-balance transfer rate will always be better than paying off the balances in a lump sum with a loan and then making the loan repayments.
For more information on this have a look at Neil Hawkins' excellent article on How to use Balance Transfer Credit Cards'.
2. To make a big one-off purchase
Sometimes, annoying and costly things happen and you need a lump sum to make a purchase you couldn't have saved for.
If your purchase can be paid back quickly (in less than twelve months) then your best bet will be to get a credit card with a 0% rate on purchases and pay your borrowing back within the introductory period.
Depending on the length of the interest-free period of the credit cards on offer to you, you might even find that a credit card with a very low interest rate will be cheaper.
If the purchase is over £1000 and/or will take you over a year to repay then the best way for you to borrow will be with a loan.
This is not because loans can offer cheap borrowing, as the best credit cards for purchases can, but just because there isn't really any other way to get a lump sum.
Find out more on how to get the best loan for your borrowing in the 'which loan should I use for borrowing?' section.
3. To get some cash before payday
So-called payday loans or cash advance loans are all over the high street at the moment and often hit the headlines for their eye-watering interest rates. They are intended to be the shortest type of loan you can get.
However, because of their high interest rates they should be treated with extreme caution.
If you find that you often run out of money before payday it would be better to get a credit card to use for purchases and pay back the money within the interest-free period then risk this type of borrowing.
Neither product should be your first port of call, though, both speaking to your bank to get an interest-free overdraft on your current account or speaking to your employer to get an advance on your pay would be preferable.
Which credit card should I use for borrowing?
Don't use credit cards that come with reward schemes such as cashback or points schemes like airmiles for borrowing. Not only do these credit cards usually come with high interest rates any money that you would save on the offers will be outweighed by the interest you're paying.
Instead, use credit cards that fit the borrowing you need and only use them for that borrowing.
We always get asked whether deals are bad credit cards but the truth is most 'bad credit cards' are actually misused credit cards. It's much better to have several credit cards for different jobs than to face penalties for trying to make one credit card do too much.
Which loan should I use for borrowing?
The main difference between loan types is secured loans and unsecured (or personal) loans.
Secured loans allow you to borrow against something that you already own (usually your house) this is more secure for the lender but most certainly not for you. It means that if you default on the loan you could have your home taken away.
More than this, though, secured loans are dangerous because they usually have a variable interest rate. That means that you could end up spending much more than you planned on interest, potentially putting you in debt for longer.
After that, though, the best way to compare loans is to simply find the one that can give you the money you need for the lowest interest rate. Your aim should always be to pay back the money as soon as possible and not to find the lowest minimum monthly repayment.
Making small monthly repayments is the worst kind of false economy.
For example, say you borrow £2000 with an Alliance and Leicester personal loan.
According to Alliance and Leicester's initial quote service if you pay it off within a year with monthly repayments of £182.82 you'll pay £2,193.84 overall.
If you pay it off in three years, however, with monthly payments of £50.18 you'll pay an eye-watering £3,010.80 overall.
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