debt is bad. There are many good reasons to borrow money, these include things
like taking out a mortgage to purchase a house, having a student loan and
borrowing money for emergencies. In contrast, some bad reasons for borrowing
money include borrowing money to get through the month. This kind of borrowing
can lead to escalating debt and is often the reason people see their debt
spiralling out of control.
if you are borrowing money you will be charged a fee for doing this in the form
of interest and this will vary between the different types of debt. The level
of interest you pay will determine how expensive or cheap your debt is and, as
such, the best way to borrow money is often determined by which form of debt is
the cheapest ie which has the lowest interest rate.
order to compare the cost of different debts and determine which is best for
you, you need to consider the Annual Percentage Rate (APR).
What is APR?
is the amount of interest you will pay on your debt each year. It is calculated
to include the cost of any borrowing plus any fees involved with the debt. This
gives you an overall ‘cost’ of debt and is therefore the best measure to use
when comparing debts as there are no hidden charges. There is a legal
requirement for the APR to be shown on any debts so that you can make a fair
you’re trying to decide between paying off your debts and putting your money
into savings then you will need to compare the APR on any debts to the Annual
Equivalent Rate (AER) on savings. The AER is designed to allow easy comparisons
between savings options but it is also the savings equivalent of the APR so can
easily be used in this way.
So what is the APR? APR is the true cost of borrowing money. It takes into account:
The interest rate being charged by the lender
When the interest is charged (daily, weekly, monthly or yearly)
Any other costs
As the APR takes into account initial fees and any other costs, it is a true reflection of the cost of borrowing money.
The higher the APR, the more expensive it is to borrow.
Whilst every lender is required to disclose the APR on their products, this doesn’t mean that you are guaranteed to get that rate. In reality there can be as little as 51% of applicants who receive the APR advertised, which means that up to 49% of people could get a different (usually higher) APR.
You won’t know the APR you are going to get until after you’ve applied for the debt, so bear this in mind before making an application. Each time you apply for new debt this will be recorded on your credit file meaning you should avoid applying for too many different products at the same time. It can be useful to check your credit report before applying for any debt as a good credit rating will help maximise your chances of being offered the advertised APR. You can learn more about credit ratings here (link to credit rating section of website).
You can find more information on APRs and things to be aware of here.
The table below shows the cost of borrowing £5,000 for 5 years:
£5,000 borrowed for 5 years
Monthly payment / total paid
£94 pm = £5,635 in total
£128 pm = £7,678 in total
If you were to borrow at 20% APR, you are paying £34 pm more than if you can arrange to borrow at 5% APR. And the total you pay will be £2,000 higher!
So if you do have debts, try to borrow with the lowest APR you can find.
Here are some different types of borrowing with typical long term APRs:
Type of borrowing
Typical long term APR
5% - 10%
Agreed bank overdraft
Credit card / store card
20% - 40%
Bloke with a big dog
An arm and a leg!
360% or more(*)
(* you often see much higher numbers quoted by payday loan companies - this is because they have to quote the cost of borrowing for a year, but these loans are often just for 30 days or so.)
This video describes how interest is calculated using an Annual Percentage Rate (APR).
How can I pay lower interest on my debts?
First of all, work out what APR applies to your debt. You should be able to find this on a credit card statement or your last statement of debt. If you can’t find this, phone up your lender and ask them.
Make a list of all of your debt and the APR that applies to them.
Then consider whether there are opportunities to transfer part or all the debt to another lender with a lower APR.
Use comparison websites to find out APRs for various types of debt. Find out what the APR is currently on your mortgage (phone your mortgage company).
Work out how much of your debt would benefit from transferring to the lower rate debt.
If you wish to transfer your debts, apply for the new debt and pay off the old debt.
Some key points
Once you have paid off or reduced your balance on your credit cards, don’t spend on them again. Be careful not to build up new debts on your credit cards with high interest rates.
Try to continue paying the same amount towards your debts as you are paying now, even if your debts are going down. This will mean that the outstanding balance comes down quicker.
If you can’t afford to pay the same towards your debts as you are paying now, reduce the amount you pay. But don’t reduce it to the minimum. The more you pay, the quicker the problem will go away.
Think carefully about transferring your debts to your mortgage. Your mortgage is secured on your house. If you cannot afford to pay your debts, the lender can and will repossess your house. If your debts are unsecured and you cannot afford to pay your debts, you will not lose your house.
I want to pay off some of my debts, which ones should I pay?
This is simple. Pay off the debts which are the most
expensive first ie the ones that have the highest APR.
And if you are paying more than the minimum amount, pay
the minimum amount on the cards with the lowest APR and pay the rest on the
card with the highest APR.
Can I move my debts to a credit card with a 0% interest
This may well be possible depending on the size of your
debts and whether the credit card company is prepared to give you a credit
card. Transferring to a 0% interest rate could save you a significant amount of
interest payments but bear in mind there is likely to be an initial fee
incurred when you transfer the balance, this is often around 3% of the amount
Things to look out for with credit cards with 0% interest
After the initial period where the interest rate is 0%,
the APR will go up to a high level. Be ready to find another credit card deal
and transfer your balance to the new card.
Have a plan ready in case you cannot find a new card with
0% interest rate.
If you can’t obtain a credit card with 0% interest rate or
are worried about having to switch balances to other cards in the future, you
may be able to use an existing credit card to reduce the interest you pay.
Phone up the credit card company and tell them that you need cheaper debt and
would prefer to remain with them.
How do I improve my chances of being lent money?
If you apply to lend money, the lender will check your credit score. A credit score is a measure used by lenders to help them determine
if they think you are reliable and can afford to manage any new debt. They use
this to decide whether or not they want to lend to you and, if so, at what
Typically, the better your credit score, the more likely
you will be to have credit applications granted and you’ll also be offered a
better (lower) interest rate, meaning debt is cheaper for you.
There are lots of factors that go into calculating your credit score. These include but are not limited to the following:
Information about any existing borrowing: This will include details of all your debts and repayments, outstanding balances and defaults.
Information from the electoral roll: This will include your address and confirm that you are who you say you are. If you’re not on the electoral roll you’ll probably get turned down for credit so make sure you register to vote.
Court records: Including details of any County Court Judgements (CCJs) that are against you and if you’ve ever been bankrupt or had your house repossessed.
Details of people you are financially linked to: This can be anyone with whom you have a joint credit product eg a joint mortgage or credit card. If the other person has had financial difficulties in the past then this can impact on your own credit score.
Information usually remains on your credit report for up to 6 years.
You should be aware that student loans are not taken into account when determining your credit score.
There are currently three credit rating agencies Experian, Equifax and Callcredit. Each of these agencies will put together a credit score but they do not all use the same formula. This means that you don’t have a universal credit rating and each agency could assign you with a different rating. In addition, different lenders may base their decisions on the rating produced by one or more of these agencies so it’s important to know that the information held by all three agencies is correct.
Even small errors on your credit report can cause problems
in getting new credit so it does make sense to check your score before taking
out any new debt eg a mortgage, loan or credit card. If you find errors on your
record you can flag these with the credit rating agency and get them corrected
but this might not happen immediately. It can therefore be worthwhile checking
your score every 1-2 years to make sure all the information is correct and
ready to go when you are.
You have the right to see your credit report and you can
do this for as little as £2 from the three credit rating agencies. However, the
credit rating agencies often offer you the option to sign up to constant
monitoring of your credit score (for a regular fee) and make this seem
attractive by giving you a month long free trial. This can be a useful way of
checking your score for free but it’s unlikely to be necessary to track your
score on a monthly (or more regular) basis, so you should ensure that you
cancel your subscription before you start being charged for the service.
For more information on how you can check your credit
score for free, click here.
It can be very difficult to get credit if you’ve never had
credit: In these cases you don’t exist to the credit rating agencies and
effectively have no track record. It makes sense that a lender would not want
to lend to you if they didn’t know that you were a reliable borrower. If you
think you might fall into this trap then you can build up your credit rating by
taking out a credit card with a small limit, spending on this each month and
then paying off the balance in full. This will mean that you don’t pay any
interest on the money you borrow and will also start to give you a credit
Lots of different applications can damage your credit
score: Each application you make will be recorded and the more you make, the
worse your credit score may be. This is because if you are rejected then you’ll
likely want to apply somewhere else. You should therefore prioritise your
applications and avoid applying for more minor borrowings such as credit cards
in the lead up to applying for more significant borrowings such as a mortgage.
Any applications stay on your record for one year so bear this in mind when
deciding when to borrow. To avoid multiple applications you can use a free
online eligibility calculator
to see which products you may be accepted for.
Beware of fraud scoring: Credit rating agencies will track
how consistent your applications are so you should make sure you use the same
information across all applications otherwise they may not think you are
legitimate and you may get turned down.
Types of Debt
Debt comes in many shapes and sizes such as mortgages, student loans, credit card debt etc.
Recent years have seen a rise in 'payday loans', offering what many people think will be a quick fix to their debts which they can clear once payday comes around. However, payday loans can quickly become very expensive. Take a look at the information below so see how payday loans work and how quickly the costs can escalate.
loans are meant to be very short term loans to tide you over if you need cash
before you get paid, and cannot access any other form of cheaper borrowing.
They are a very expensive way of borrowing money and if not quickly paid off in
full, your debt can quickly build to a problematic amount. Only turn to a
payday lender once you have exhausted all the other alternative ways to borrow.
If you really have no alternative, make sure you shop around, for example by
using an online comparison site, to make sure you’re getting the “least worst”
A good guide to payday loans and alternatives can be found here.
If you borrowed £100 for 30 days and the interest was 0.8% per day, you would be required to pay back £124 at the end of the 30 days. If you used a credit card, you would be required to pay back £100 if you pay back within the interest free period. Even if you didn’t pay back the money immediately, the interest on the credit card would be around £2. The total you owe after one month would therefore be £102.
The amount owed to the lending company can quickly build up if you don’t have the spare cash each month to pay back the loan. In the example above, borrowing £100 for 30 days means you have to pay back £124 at the end of the 30 days. If you need to borrow £124 to pay back the loan and borrow for another 30 days, you will owe £154 at the end of the period. If you continue doing this for months, the loan builds up very quickly…
Amount owed at the end of the month (borrowing for 30 days each month)
And all from borrowing an initial amount of £100! This shows us that payday lenders should only be used as a way to borrow for the short term, if at all.
Payday loans are something to avoid if possible. However, if you do get into the position where a payday loan is the only option and you find you cannot pay back the loan and need to borrow again to do so, wait until the last minute to borrow again. Look what happens to the amount owed if you wait until 5 days before payday so that you are borrowing for 5 days rather than 30 days.
Amount owed at the end of the month (borrowing for 30 days each month)
Amount owed at the end of the month (borrowing for 5 days each month
So if you have to borrow using a payday loan, don’t roll over the loan, but pay back the loan using your salary and then take out another loan when your bank account starts to be insufficient to pay your bills and living expenses.
It can be comforting to have savings alongside debt but this
could be costing you money! The key is knowing the APR you are paying on your
debt and the interest you are earning on your savings. If your debt APR is
higher than your savings interest rate then you could save money by using your
savings to pay off your debt.
Watch the video to find out how this works.
There are some exceptions to this…
Interest free debt: for example, if the only debt you have
is a 0% credit card then you are effectively borrowing money for free and, as
long as you are on this 0% rate, you may be better holding some of your money
in savings. Bear in mind that any 0% rate will eventually end and at this point
you may want to use your savings to pay off your debt or move quickly to find
another 0% deal.
Penalties: You may be locked into your debt and be subject
to early repayment fees, depending on the size of the penalty it may still be
worthwhile using your savings to pay off your debt but make sure you understand
the numbers involved before making a decision.
Here’s an example of where using your savings to pay off
your debt could help you save money:
Let’s say you have £5,000 of credit card debt with an APR of
. The interest on this is £1,000 a year. At the same time you have £5,000 of
cash savings, earning interest at 0.5% pa. This means you earn £25 interest
If you used your cash savings in this example to pay off
your debt then you could be
£975 a year better off!!
We are not Independent Financial Advisers (IFAs) and nothing on this website should be construed as independent financial advice. If you feel you would benefit from speaking to an IFA about your personal circumstances, you can find more information here.