Choosing how to borrow

Freedom Finance looks at the different types of borrowing, what they’re used for, and the upsides and downsides of each one.

Deciding which kind of loan, credit or other sort of finance you need can be tricky. Here we’re looking at the different types of borrowing, what they’re used for, and the upsides and downsides of each one.

Credit Cards

A credit card is similar to a loan, but rather than receiving money, you receive a line of credit. You must pay the credit back in a specific time frame, along with any interest due.

A credit card might be used for big-ticket items. If you want to buy a holiday or a smart TV, rather than having to pay big money upfront, the credit card helps you spread the repayments over a few months to make things more affordable.

If you’re buying online, credit cards are a quick, secure way to pay. Credit cards are accepted in most countries around the world, which makes them handy for holidays and travelling.

Upsides? When used well, credit cards can help improve your credit score. You also won’t be charged interest if you pay off what you owe in full each month, so can be a cost-effective way to borrow. Credit cards can be used in many countries around the world and you’re usually protected against fraud. They can also come with interest-free periods that can help you spread the cost of purchases or transfer a balance.

Downsides? Credit cards can be expensive if interest is allowed to build up. You’ll need to make the minimum payment each month, but not clearing your monthly balance in full will mean you’re charged interest on what you owe. Late charges and penalty fees can also occur. And try to avoid using a credit card to get cash out of an ATM – you may be charged a fee by your provider.

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Personal Loans

A personal loan is also known as an unsecured loan. ‘Unsecured’ means that this is a loan that isn’t secured against your property.

You receive your personal loan, then pay it back in monthly instalments. You’ll also be charged interest. The loan interest may be set at a fixed or a variable rate over the loan term.

Personal loans are an option for lots of people. They’re fairly flexible, as you have a choice over how long you want to repay them. Most borrowers choose to make fixed repayments for between one and five years. Some loans also offer the option of a payment holiday (a feature that allows you a payment-free window) of about two or three months at the start of the agreement.

The best loan rates are generally for borrowers looking to make repayments over three and five years, meaning you’ll often pay a higher interest rate to borrow over a shorter term.

Upsides? A personal loan makes a purchase affordable by spreading your costs. They can help you to manage your monthly budget should you wish to consolidate your debts – and, if you pay it regularly and in full, it can potentially improve your credit score.

Downsides? Top deals are only open to those with high credit scores. Missing loan payments may affect your credit score, potentially impacting your ability to obtain credit in the future.

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About unsecured personal loans

About small loans

About credit scores

Homeowner Loans

If you’re a homeowner, you can also consider a homeower loan, sometimes called a secured loan or a second-charge mortgage. A homeowner loan is a loan that’s secured against your property, giving you the opportunity to borrow larger amounts over longer repayment periods. However, if you’re unable to repay your loan, your lender could repossess your property to recover their costs.

To be eligible for a homeowner loan, you’ll need to have enough equity in your home and be able to afford the monthly repayments. You don’t need to remortgage to take out a homeowner loan, it’s simply added alongside your first mortgage.

Your home may be repossessed if you do not keep up repayments on a mortgage or any other debt secured on it.

Upsides?

  • You can borrow larger amounts: homeowner loans range from £5,000 up to £500,000+. With a personal loan, the maximum amount you can borrow is £25,000, so a homeowner loan might be the better option if you’ve got big plans in mind.
  • There are longer repayment terms: you can pay back a homeowner loan over 1 to 30 years, giving you a lot more scope to spread the cost of your borrowing.
  • You can get advice: as a homeowner loan is a type of mortgage, you can get advice from a specialist second-charge mortgage adviser on which loan option is right for you.
  • You can get accepted with a lower credit score: homeowner loan eligibility isn’t as dependent on your credit history. This means you could have better homeowner loan options compared to your personal loan options.

Downsides?

  • Your home could be at risk: if you can no longer repay your loan, your home could be repossessed by your lender. Although this is often a last resort, it is a risk that needs considering before you secure a loan against your home.
  • Missed repayments can negatively affect your credit score: just like with any type of borrowing, a missed monthly repayment will be recorded on your credit file and can impact your future chances of accessing credit.

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About homeowner loans

Mortgages

mortgage is a loan which uses property or land as collateral. The borrower enters into an agreement with a lender (usually a bank) where the borrower receives cash upfront, then makes payments over a set amount of time until the lender is paid back in full.

All mortgages have two parts. The capital, which is the money you’re borrowing for the property or land, and the interest, which is a percentage charge made by the lender on the amount of capital you’ve borrowed.

There are also two ways to pay off a mortgage: repayment and interest-only. With a repayment mortgage, you pay back a small part of the loan capital and the interest each month. Assuming you make all your payments, you’re guaranteed to pay off the whole loan at the end of the term.

With an interest-only mortgage, you’ll get cheaper monthly payments on your loan, but you’re not actually paying back any debt. At the end of the mortgage term you’ll still owe your lender the amount that you borrowed, so you’ll need to have a plan to repay the debt before you take out the loan.

Also, depending on what kind of loan you want, a mortgage can also be first charge or second charge.

A first charge mortgage is just a fancy name for a standard mortgage. ‘First charge’ means this is a loan for a home on your property if you have no outstanding mortgage balance.

A first charge mortgage is just a fancy name for a standard mortgage. A ‘first charge’ occurs when you take out a home loan while having no outstanding mortgage balance. It’s a first charge because it’s the only charge.

A second charge mortgage helps you to use your property’s equity as a security against another loan. Equity is the part of the property owned by you. This means you will have two mortgages on your home – or two charges.

Upsides? By borrowing such a large amount from a lender, you are likely to get a lower interest rate than other types of borrowing. This is because the lender has the security of repossessing your property if you don’t repay the debt.

Downsides? If mortgage payments are missed, it may damage your credit score, which can potentially affect your chance of obtaining credit in the future. You will still be expected to pay the debts, along with penalty charges and even face legal action if you continue to default (fail to make payment).

Mortgages are secured against your property, which means that your property could be taken back by the lender if you fail to make the agreed monthly payments. This is what is known as ‘repossession’.

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About mortgages

About secured loans

Overdrafts

An overdraft allows you to borrow money through your current account. It means that, even when your bank balance is zero, you can take out money up to a certain limit that has been agreed with your bank – this is an overdraft.

Upsides? An overdraft provides flexibility as you can change the amount borrowed within limits. Interest is generally only payable on the amounts borrowed, whenever you’re using your overdraft facility.

Downsides? An overdraft can’t normally be used for large amounts of borrowing. Also, banks can change the limit of the overdraft at any time or ask for the money to be paid back in full sooner than expected.

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About loans online

About small loans

About unsecured personal loans

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