Borrowing money is like a superpower. Used right, it can turbocharge your life, letting you buy things – like a house – that’d otherwise be out of the question. But if handled incorrectly, debt can be dangerous. Fortunately, it doesn’t have to be: here’s what you need to know to wield your great power with great responsibility.
Know the jargon. When you owe money to an institution, you’ll normally be quoted an interest rate. That interest is a percentage of the loan, and is normally quoted annually. A 10% APR (annual percentage rate) on a £100 loan means that you’ll have to pay £10 in interest each year – as well as eventually paying back the original £100 (known as the “principal”) you borrowed.
Assess the interest rate. In general, a lower interest rate is better – it means a cheaper loan. Rates can vary wildly: some products are interest-free for a certain amount of time, while others might charge you interest from day one. Make sure you’re comparing APRs: sometimes you might see daily or monthly interest quoted instead, which will look like a lower amount but likely work out to be more expensive when annualized.
Check what kind of loan it is. If you take out a loan with fixed interest, your payment will be the same each month. But if you have a variable rate loan, your monthly payments will rise when central bank interest rates do. Make sure that you’ll still be able to afford the payments if that does happen. It’s always best to prepare for the worst.
Think about what you need. If you can’t find an affordable loan for the thing you want, think about if you really need it. If you can go without it altogether, great. If you do want it but can go without it for a while, it might be better to save and buy it later rather than taking out a high-interest loan.
Look at the fees. Read the small print carefully in case there are penalties for late payments, administrative costs, or early repayments. Speaking of which…
Plan your repayment. It’s best to know in advance how you’re going to repay the loan. Build a budget to figure out how to pay the interest and start setting money aside to pay the principal. If there’s a payment deadline, make sure you meet it – set a calendar reminder, if you think that’ll help. Missing a deadline can hurt your credit score, as we explain here.
If your debt’s getting overwhelming, you’ve got options. “Debt consolidation”, which lets you roll all your loans into one (hopefully) lower-interest loan, can help. So can “money transfer” cards, which give you cash for a small fee, waiving interest sometimes for up to two years. If things are really bad, a debt counseling charity could be a big help: they’ll advise you on the best course of action for your particular circumstances.