A jargon-free look at the pros and cons of different credit options
There are many different credit options out there: from credit cards and payday loans to second mortgages and remortgaging. With so many choices, how are you supposed to know which is the best credit option for you? In order to help you make the decision that’s right for you, we take a jargon-free look at the pros and cons of these different options.
What is it: credit cards are flexible revolving credit lines. What this means is that you can borrow and pay back and re borrow and pay back as often as you like up to an agreed limit of borrowing. Credit cards can also be used in most situations in most countries of the world to purchase goods or services.
Pros: you get the flexibility to be able to continually increase and reduce your borrowing without having to apply or be approved each time is very convenient. Many credit card companies offer 0% interest cards, for a certain periods and that can be very competitive. They are a good way to borrow a relatively small amount for a short period of time.
Cons: Many people fall into the trap of building up large balances and only paying of the minimum amount required each month (usually 2%-3% of the balance). This is a very ineffective and expensive way to borrow and these balances very often end up being cleared through debt consolidation. Typical interest rates for credit cards outside the 0% period are usually between 15 and 20%.
What is it: a payday loan is a relatively small (between £100 and £500) short term loan that is used as a stop gap during a month to get people through to pay day. In some ways it is like a very expensive overdraft. This industry has seen a huge surge in recent years, but there has now been a crack down.
Lenders charge a rate of up to 0.8% per day. The typical APR for a payday loan works out at over 1,000%.
Pro: payday loans are one of the quickest forms of credit to get approved. Some lenders can have the money in your account in hours. They can serve a purpose in a position where someone needs to get hold of money very quickly and only needs the loan until there pay day.
Cons: Borrowing the money is very expensive in terms of the interest charged. People sometimes take out payday loans without giving any real thought to how they are going to pay it back. With the rate offered, if a borrower can’t pay back their loan come payday, the amount they need to pay back will grow, and can quickly mount up although thanks to the recent legislative changes these fees and charges have been significantly capped.
What is it: remortgaging is moving your mortgage from one provider to another in order to get the best deal. People may choose to remortgage because their current mortgage doesn’t fit what they want anymore, or because they want to borrow more money. With many people having equity in their houses, using a remortgage to raise extra money if required can be the cheapest way to do it. .
Pros: a remortgage can very often attract the lowest rate of interest for people who want to borrow money. Because the loan is secured against a property on a first charge basis the risk to the lender is considerably lower than any other form of borrowing.
Cons: You are borrowing extra money against your property. Lenders can have very restrictive policies when it comes to agreeing mortgages, which can make them more difficult to obtain. It can take a long time and a lot of effort to go through the process of getting the loan. Your current mortgage can attract penalties if you change the lender, which can be financially significant.
What is it: an unsecured loan is not secured on a property or any other asset (physical thing). Typically unsecured loans are set up over 3 – 7 years depending on the individual(s) borrowing the money and are between £3,000 and £15,000.
Pros: an unsecured loan can be a low cost and relatively easy way to get money particularly for people with good credit ratings. These loans are not secured against any property you own. The term of unsecured borrowing tends to be shorter so you pay less interest. There is a finite term to the borrowing unlike credit cards, which means you know when the loan will be paid off.
Cons: The shorter term means that the monthly payment on larger unsecured loans can be prohibitive for customers. The best rates tend to be for those wanting to take a loan over £7,500 for between three and five years, meaning that those who want to pay the loan back over a shorter period of time or borrow less may be subject to a higher interest rate. Due to the fact that there is no security for the lender is generally much harder to get accepted for an unsecured loan.
What is it: a second mortgage, sometimes known as a homeowner loan, is a credit agreement backed by the equity in a property owned by the borrower. There is a charge on placed on the property for the second mortgage lender which sits behind the charge in place for the mortgage company.
Pros: second mortgages are generally for larger amounts than unsecured loans, and the repayment period is more flexible and can be much longer if this is required to making it easier to manage the payment within your monthly budgeting. The rates are very often lower than other forms of borrowing depending on your circumstance. As your property acts as security, it can be easier to get accepted for a second mortgage, as long as your property is worth at least £75,000, you have equity available and you have a steady provable income. The criteria on second mortgages, is very often slightly less restrictive than with a remortgage, which means you can have more chance of getting accepted.
Cons: as a second mortgage is secured against your property, failure to make repayments could result in the loss of your house. There are fees involved with a mortgage to cover the cost of valuations, legal searches, credit searches, processing and other costs.
This is just a quick overview of the main credit options offered. Each person will have different circumstances and therefore different options will suit different people better: for example, a 0% credit card might suit those looking to borrow £500 for a few months, while someone who has equity in their property and wants to release £30,000 may suit a second mortgage.
To find out more about the differences between secured and unsecured loans, visit our types of loans explained page.