Taking a student loan, getting a mortgage or using a credit card for occasional spending: just some of the common ways to borrow. Borrowing money can therefore be an important part of meeting some of your goals, but it’s important to understand the fundamentals so you can balance your debts.
Table of contents
What is borrowing?
When you borrow, the lender (or creditor) gives you money with an agreement that you will repay it, usually over a defined period. Often, you will need to pay back slightly more than the original amount. Credit is a flexible form of borrowing with ongoing access to money, instead of a fixed sum.
Key terminology
- Principal: the amount of money you are borrowing.
- Term: the time period over which you’ll pay off the loan.
- Monthly repayment: the amount of money you’ll pay off each month, which may be fixed or variable.
- Interest rate: the extra you need to pay back on top of the loan amount, usually shown as a percentage.
- APR: Annual Percentage Rate, the amount of interest and any fees you will pay back each year on top of the loan amount.
- Credit score: a number that represents your reliability in repaying debt, compiled by a credit agency.
- Default: failure to repay your loan.
- Secured debt: if you fail to repay this type of loan, the lender can take an asset in response, usually a home or car.
Is borrowing right for you?
When deciding if borrowing money is the right thing for you, it’s important to weigh up the risks and the benefits.
The risks of not making repayments can include losing an asset (such as your home), getting a bad credit score (which can make it harder to borrow in future) or even going to court. If you are at any risk of not being able to make repayments, for example if your job is insecure or you already have other debts, borrowing may not be the right step.
On the other hand, in some scenarios, borrowing may be the right call. These might include:
- Buying a home: it’s usual to take out a mortgage, a special type of loan for buying a property. Property is normally a very big expense and can become a valuable asset, so it can make sense to borrow for this purpose.
- Education: gaining more education and qualifications can help you earn more. This can make borrowing to pay for education a sensible investment.
- Starting a business: you may need to borrow to get your first equipment, premises or digital platform. Again, this sets up the potential to earn more and repay the loan with your proceeds.
- Building your credit score: you can build a strong credit score by using small amounts of credit, for example using a credit card for a few items each month, and making sure you repay promptly. This can help you access bigger loans, like a mortgage, in the future.
Of course, borrowing isn’t always a choice. If you’re borrowing to cover everyday essentials, see the section below for some practical guidance
Should you borrow to cover everyday needs?
Rising numbers of people are borrowing to cover everyday bills like utilities or food shops. This can be risky because you may not have the ability to make your repayments if you frequently add debts to your pile. Without a way to make more money and ensure you don’t end up in this situation again, you might build up too much debt, too quickly, putting you into a spiral as you try to manage everyday costs and repayments on top.
Short-term borrowing, such as using a credit card or a payday loan, can be much more expensive than longer-term loans, with higher interest rates.
Tracking your spending and creating a spending plan (which you can do on your Maji account) can help you avoid running out of money at the end of the month. Building a solid buffer, i.e. slack in your budget, can also help cover any unexpected expenditure.
What do you need to know before taking a loan?
There are a few key questions to ask before you take out a loan, including:
- What is the APR on the loan? This can help you compare the interest and fees you’ll pay back across different loans and providers.
- What is the loan term? Are you prepared to pay back quickly, therefore paying less interest over time? Or would you rather hold the debt for longer but have lower monthly repayments?
- What will your monthly repayments look like? Does this fit into your budget?
- What happens if you miss a repayment?
- Can you get a better deal, e.g. a lower interest rate, elsewhere?
- Is a loan strictly necessary or could you cover the cost through savings instead?
Taking your time to research your options and plan out your repayments can make a big difference to keeping debt manageable.
How to find a personal loan
To get the best loan deal, it’s important to compare different options. Before getting started, it’s a good idea to check if you are eligible using a calculator like the ones provided by Clearscore or Experian. Checking before you apply can help protect your credit score by lowering the number of ‘hard’ credit checks on your account (which can signal poor money management).
It’s also a good idea to make sure your credit score is as strong as possible. This might involve checking your credit reports, fixing errors and making sure you are repaying debts on time (see MoneyHelper’s guide for more details).
You can compare loans through comparison pages, including those offered by Clearscore and Experian, linked above. You can also check individual lenders separately, for example the major high street banks. Comparison sites may not always cover every lender on the market.
Make sure you check the APR and not just the interest rate when looking at which loan is cheapest. The APR includes fees you need to pay, so will reflect the cost of the loan more accurately.
Getting borrowing right
Borrowing is neither inherently good nor bad – it’s a tool, and like any tool, it works best when used with care. Understanding the terms before you commit, keeping repayments manageable, and having a plan if things change can make all the difference between debt that works for you and debt that weighs you down.
If you’re struggling with debt or unsure where to turn, free and impartial help is available from organisations like StepChange and Citizens Advice. You don’t have to figure it out alone.
