Mortgages v credit cards v loans v overdrafts

First Charge Mortgages and Secured Loans

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 installments.
  • 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. 

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.

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, car loan or business loans to assist in the running of your company.

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.

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.