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Tackling your debts

How to choose and use credit responsibly

Posted 14 December 2015 by Christine Walsh

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Do you know what you need to consider when you’re interested in a financial product? Make sure you know how to choose and use credit responsibly with our blog.

With so many credit options out there, do you know how to choose the credit that works best for you and then use that credit in the right way?

The truth is, there’s nothing wrong with taking out credit and having debt to pay off, as long as you know exactly what you’re getting yourself into and how you’re going to pay it back, and you have a good reason to borrow in the first place.  

We’re going to have an in depth look at how to do credit the right way, outlining the key things to look out for when you’re considering borrowing. 

 

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What’s is the APR?

APR stands for annual percentage rate and tells you the amount that you’ll pay to take out a particular line of credit. It covers everything, including any fees, as well as the interest rate and tells you how much your borrowing will cost you, on average, over a year, so it’s important you understand what it is.  The bigger the APR the more expensive the borrowing is.  APRs can vary from around just 4% on loans from high street providers to over 1,500% for payday loans (the interest rate on these is capped at 0.8% per day). 

There are two types of APR: personal APR and the representative APR and it’s important to understand the difference. 

The representative APR shows you what a certain number of people who apply for that line of credit will pay. It does not show you what you will actually pay. However, mortgages are the exception, as the APR shown with a mortgage is what you will actually pay and you’ll either be approved for it or not. For all other credit the APR changes for each applicant, and is based on the lender’s own assessment of your credit risk, so you won’t actually find out your APR until you’re accepted.

Now, the regulations state that the representative APR must show the rate at least 51% of people who are approved will pay. But, if you think about it, that leaves 49% of people who may not be paying that amount. So the moral here is, don’t be surprised if you are offered credit at more than the representative APR. If you’re worried about your credit history and find that you are being offered an APR that is higher than the representative example, there may be ways to improve your credit score. Have a look at our blog, Is your bad credit history having an impact on your life? to find out how to work on this.  

Your personal APR, as you’ve probably guessed, is the APR you will be offered if you are approved for the line of credit. It’s the amount the lender wants you to pay for them to feel comfortable about lending to you, based on their assessment of your riskiness as a borrower. They will make that assessment based on your credit history combined with other information you’ve put on your application form.  Always be sure to check your personal APR and that you understand what you’re expected to pay back before signing any agreement. 

 

Credit card or loan?

As well as looking at the interest rate and APR you should also give some thought to what type of credit would be right for your circumstances – for example, should you go for a loan or credit card?

This really depends on how much you want to borrow and how long you’ll need to pay the amount back. If you only need a relatively small amount and you know you could pay it back quite quickly, a credit card could be the best option for you. This is because there are credit cards available that give you an interest free period: you can find and compare deals on Uswitch. If you’re sure you can pay the money back during the interest-free period, then you could potentially find yourself borrowing without paying any interest on the amount you borrow. 

The flip side to this is that once the interest free period runs out the interest rate may not be the most competitive, and you could end up paying a higher rate than you want.  Credit cards are a flexible way of borrowing – although you must always pay the minimum payment each month, you can pay back as much of your balance as you can afford as quickly as you want.  The faster you pay off the card the less interest you’ll end up paying.

If you want to borrow a larger amount, over a longer period of time, and have fixed monthly repayments, a loan may be more suitable. If you prefer to give yourself longer to pay the money back at a set rate each month then it can work out cheaper to get a loan – you just need to know the difference in the interest rates. You can compare the best loan rates here.

 

Key points to consider

Gather a “credit checklist” of all the things that you should ask yourself before you apply or agree to taking out any line of credit. If you follow these tips you should find that you’re able to manage your borrowing, and that there are no nasty surprises down the line:

• What is the APR, specifically my personal APR?

• What’s my plan to pay this money back and are my circumstances likely to change in the future?

• Is this type of credit right for me? Does it fit with how much I want to borrow and how long it will take me to repay the money?

• If the interest rate doesn’t start straight away, is it clear when it will start and how much it will be?

• How long would this financial commitment last for?

• Have I read an understood the small-print?

• Do I need to buy this item now, or could I wait to save up for it?

If you approach a responsible lender, then it’s very likely that most, if not all, of these points will be covered when you’re discussing taking out the credit. Lenders do have a duty of care to lend responsibly, and are kept in-check by their regulator, the Financial Conduct Authority (FCA). If you come across a financial advert, on television, or in any format, that you think is unfair or misleading, you can report it to the FCA.  They can then decide if it’s something they need to look into. 

 

Good borrowing v bad borrowing

Being a responsible borrower also means understanding when it makes sense to borrow money – and when it doesn’t.  Some examples of potentially problematic borrowing are:

• If you are thinking of borrowing money in order to meet the repayments on an existing loan or credit card.

• You need to borrow money to pay for essential living costs such as food.

• You are thinking of borrowing but you know that you have no real disposable income to cover the repayments.

All of these cases may be symptoms of more serious financial problems and you should speak to a debt advisor.

An example of when it may make sense to borrow is:

• You know you have enough money free each month to make repayments but you need to buy something now – for example your car needs work to pass its MOT and you need it for your work.

We hope this has made it clear what you should be thinking about when you’re applying for credit and how it is possible to choose and use credit well. However, if you’re already in a situation where your past borrowing is are having a serious effect on your life and you are struggling to repay what you owe, you should speak to an expert. Use the options on the left to contact our debt advisors. 

 

by Christine Walsh

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To find out more about managing your money and getting free debt advice, visit Money Advice Service, an independent service set up to help people manage their money.