mortgage-secured-loans-overdraft

How To Pick Between Credit Card, Loans & Overdraft

‘Should I choose a mortgage, credit card, loan, or an overdraft?’

Mortgage: A mortgage is a loan taken out for a property or land which is secured against your home until the loan is paid back.  Mortgages can be first charge or second charge (also known as secured loan).

Credit Card: A credit card is similar to a loan but rather than receiving cash, you receive credit which you must pay back within a specific time frame.

Personal Loan: A personal loan, also known as an unsecured loan, is a loan not secured against your home. With a loan, you receive the full amount but have to pay it back in fixed monthly instalments. 

Overdraft: An overdraft is where the credit is extended on your current account. It essentially means you are overdrawn on your account. 

First Charge Mortgages and Secured Loans (Second Charge Mortgages) 

A first charge mortgage is a high value loan that is usually taken out for the purpose of buying property. First charge mortgages can also be used to raise capital in the form of a further advance or a remortgage for purposes such as home improvements or debt consolidation

Secured loans are loans in which the debt is secured against collateral such as a house, as a second charge behind the first charge mortgage. 

Mortgages are categorised into two basic types, repayment and interest only. As the name suggests, a repayment mortgage means that the borrower repays both the capital and the interest that the remaining balance has accrued, each month. At the end of the repayment mortgage term, the mortgage debt will be fully repaid. 

An interest only mortgage allows the borrower to simply repay the interest throughout the term on a monthly basis, but must find an alternative method of repaying the debt in full at the end of the term. 

A first charge mortgage is a loan that is secured against your home, which means that your home is at risk of repossession should you fail to meet the agreed payments.

Advantages

The primary advantage of taking out a first charge mortgage is that it makes home ownership affordable. Rather than finding the huge amount of funding required to purchase a property, a first charge mortgage allows you to make the purchase and then repay the debt over a lengthy term, in manageable instalments.

A further advantage of taking out a first or second charge mortgage is that secured borrowing of such a high amount provides a lower interest rate than other types of borrowing. This is because the lender has the security of this valuable asset should the debt not be repaid.

Unlike standard loans, there are government led schemes such as Help to Buy, NewBuy and shared ownership that helps first time buyers to obtain this credit.

Disadvantages

If payments are missed, it can have a damaging effect on your credit rating, which may affect your chances of obtaining future credit. You may also face arrears or default charges and legal action which could ultimately lead to repossession of the asset the mortgage is secured against.

Some do not like the thought of carrying a huge debt for a long time.

Although the monthly repayments are affordable, the total amount repaid throughout the term as a whole is much more than the original loan amount. This is not always due to high interest rates, but often due to the frequency of interest payments over a long period. 

How long does it take to pay back?

The loan term for a first charge mortgage and secured loan is varied and you can usually choose a repayment term which suits you. However, a secured loan is typically taken out over 5 to 20 years whereas a first charge mortgage is usually taken out over 15 to 30 years.

Credit Cards

A credit card is lending which allows the borrower to make purchases based on their pre-approved credit limit, the balance of which can be repaid each month along with the interest accrued.

Advantages

A credit card is a great tool to use when making a big-ticket purchase, such as a holiday. Rather than having to part with a large amount of money, the credit card allows you to spread the repayments over a few months, making the purchase more affordable.

Credit cards are an efficient and secure way of making Internet purchases. They can be used around the world and are particularly good for travel.

A credit card offers protection against fraudulent activity so if your card is stolen, any money spent will be returned to you.

However the claim cannot be made if the card provider finds that you have been negligent, so keep your PIN safe!

There are interest free credit cards available which effectively provide you with a free loan for a specified period. This is only beneficial if you pay off your balance in full at the end of the interest free period to avoid high interest charges.

Some credit cards offer incentives to borrowers such as cash back, air miles or loyalty points.

These incentives mean that the card can be used to save money, but only if the balance if repaid in full ensuring that the value of the rewards is greater than the cost of the borrowing.

Disadvantages

The problem of ‘buy now, pay later’ is that the debt is prolonged. Some credit cards have notoriously high interest rates in comparison to other loan types, so it is advisable to pay more than the minimum payment each month to avoid your debt spiralling out of control.

Remember that using your credit card to withdraw cash from an ATM can incur a fee.

If you are late with a repayment, or exceed your credit limit, then costly penalty fees are added to your bill. For this reason, it is imperative to keep track of your credit card spending.

How long would it take to pay back?

Ideally, you want to pay the credit back on a credit card as soon as possible. If you have a zero percent interest card, you should pay back the amount before the zero percent interest term expires or else you will be charged interest payments.

Personal Loans

A personal loan is a type of borrowing, for amounts; £500 – £25,000, that is repaid to the lender over an agreed period, inclusive of interest. This interest may be set at a fixed or variable rate. Personal loans are usually taken out to consolidate existing debts into a more manageable repayment, home improvements and car loans.

Advantages

A loan allows a large purchase to become affordable by spreading the costs.

A consolidation loan can help to manage your monthly budgeting and if paid correctly, can actually improve your credit score.

Disadvantages

Taking out a loan is a commitment, and a borrower is tied into the agreement regardless of illness or job losses.

If payments are missed, it can have a damaging effect on your credit rating, which may affect your chances of obtaining future credit. You may also face arrears, default charges and legal action.

Charges are often incurred if the loan is repaid early.

How long would it take to pay back?

The average personal loan term is between 1 and 5 years.

Overdraft

An overdraft is an extension of credit attached to your current account. The lender allows the customer to withdraw money up to the agreed overdraft limit even if the current account balance is at zero. This enables cheques to be cleared which would otherwise have bounced, as well as honouring direct debits.

Advantages

An overdraft is easy to arrange, and can be set up quickly.

This type of borrowing is often cheaper than a loan because you only borrow what you need.

Interest is only charged on the value of the overdraft used, not the facility as a whole.

There are usually no early repayment charges.

Disadvantages

An overdraft can only be arranged from the lender with whom you hold your current account.

The lender has the right to cancel the overdraft at any time.

If the overdraft limit is exceeded, a charge will be incurred.

The cost of this type of borrowing is difficult to monitor, as the interest rate applied is often variable.

For more information on borrowing small amounts click here

How long would it take to pay back?

Like credit cards, overdrafts should be paid back as soon as possible as there are often fees involved. If you have been given a repayment period of a month, make sure it is repaid within this time frame. 

See what our customers are saying

Whether you're planning on some home improvements, replacing your car or simply getting your finances in order, a loan from Freedom Finance could be more affordable than you think. Use our calculator above to find the ideal loan for you. All quotations given are for illustrative purposes only. Credit subject to status. The rate you are offered will depend on your personal circumstances, credit assessment procedures and other related factors.