How much does borrowing cost?

Sometimes people borrow money from a financial organisation if they don’t have what they need right away. However, you can only do this from the age of 18. Until then you may be able to borrow some money from your family or friends. 

Be careful not to borrow more than you can pay back, you usually pay back with interest so it’s important to make sure you can afford to pay it back.  

The first thing to understand is how to calculate the interest rates for the different types of borrowing, which could be credit cards, buy now pay later, loans, overdrafts and mortgages.  

Borrowing shows the APR, which is the annual percentage rate for the cost of a loan (i.e. the original loan plus the interest and any set-up fees). The higher the APR, the more expensive the cost of borrowing.  An example could be if you borrow £1,000 with 29.9% APR and paid this back over one year, you would be repaying £1,299 (£1,000 loan + £299 interest and set-up fees).

When applying for a financial product (e.g. a loan, credit card, mortgage or mobile phone contract etc.), the company will do a credit check. This involves looking at your past behaviour, so the company can predict behaviours in the future. 

Starting to build up a credit score means when you apply to a financial organisation they want to make sure that you will be able to repay the debt, building up a credit score is a positive thing to do and the scores can go up as well as down.

Let’s explore some of the different ways you can borrow money.

Credit cards 

These are one way to borrow. They can certainly make some spending situations a lot simpler. Like debit cards, they’re great for shopping online. 

It’s important to remember that credit cards are not free money, you also have to pay interest on the money you borrow (more on this later).

What is a credit card and how does it work?

• A credit card is a way to borrow money and pay it back later (unlike a debit card, which only lets you spend money you already have in your current account).
• Your credit card is completely unique to you and has your name and 12-digit credit card number on it.
• All credit cards come with a set ‘credit limit’. This is the maximum amount you can borrow.
• You use a credit card to buy things and get a statement from your card issuer every month showing how much you’ve spent.
• You need to pay back at least the minimum amount shown on the statement – usually between 2% and 5% of the total you owe.
• If you can, you should aim to pay off the full amount each month or your card issuer will charge you monthly interest on the money you still owe – called the ‘outstanding balance’.
• Credit cards are very versatile and can be used to pay online, over the phone and in millions of places around the world

How much does a credit card cost?

Credit cards usually have different interest rates for making purchases and cash withdrawals. The higher the rate of interest, the more money you'll pay back on what you spend or take out.

Let’s say you spend £200 on your credit card and pay it off over a year. With a purchase rate of 18.9% p.a. (which stands for ‘per annum’ or per year), you’ll pay an extra £37.80 to your card issuer in interest charges because 18.9% of £200 is £37.80.

Divided by twelve, that’s £3.15 in interest charges a month. It might not sound a lot, but it soon adds up. And the more you leave on your credit card, the more interest you’ll pay.

Overdrafts

An overdraft is when the balance of your bank account drops below £0. Effectively, you’re borrowing from the bank.

Some banks will let you borrow up to a certain amount as an overdraft for free, while others will charge you interest or a fee if you go as much as a penny overdrawn. It’s worth finding out what your banks policy is, just in case.  Many people tend to agree an extent to which they can go into an overdraft, limiting excessive spending, for example:

“You may be looking to sort out your student bank account if you’re going off to university. Banks can offer you an overdraft and the amounts will vary - it could be £200, for example. That would mean that your bank lets you spend £200 more than you have, although it’s not free. Obviously, you’d have to pay this back, so budget to the best of your ability, limit your purchases wherever possible and make sure you can pay it back. However, it can be good to use it as an emergency fund or short-term credit option.”

Loans

Most people use loans when the amount they need is a bit bigger than they’d usually spend on a credit card. They’re commonly used for things like a new car (when you might get a loan from your bank) or to pay for university (when you’d get a student loan from a separate company)

Like a credit card, you’ll be charged interest on what you borrow, so it’s worth shopping around for a good rate – or even consider whether you’re better off saving up instead.

For example, if you borrowed £3,500 with a 11% APR and paid this back over one year, you would pay £3,885 overall (£3,500 + £385 interest).

Mortgages

A mortgage is like a king-sized loan people use to pay for a new house. Mortgages are repaid over a long period of time and are secured by the property you bought with it – meaning, if you don’t keep up with repayments, the mortgage provider is legally allowed to repossess your house from you.

When you are considering owning a property, you would apply for a mortgage.  You would need both a deposit (an amount you have saved up for) and an income that would allow you to repay the loan and cover your living costs.