4 minute read

Borrowing pitfalls to avoid

Having easy access to money when you need it is all well and good, but it's important to know how to manage credit and debt to avoid long-term problems.

Borrowing money isn't always a bad thing. For instance, spending on a credit card can be a good way of managing your cash flow, and for most people, a mortgage is the only way they can afford to buy a home. But there are some pitfalls to be aware of - read on to find out.

1. Borrowing more than you can afford

Every penny you borrow has to be paid back. Whether you borrow on a credit card, dip into your overdraft, or take out a loan or a mortgage, make sure that you can afford to pay it back.

Don't forget the interest you pay on top of the original amount you borrow, either! Work out exactly how much it costs you to borrow the money and then make sure that you can afford to keep up the repayments alongside your bills and other financial commitments.

If you fall behind in repayments, you could find yourself quickly getting into a spiral that sees you clocking up more and more debt, and finding it increasingly difficult to pay it off.

2. Only repaying the minimum, rather than repaying quickly

Credit cards are a simple way to buy whatever you need (or want) without having to wait and save up first. But they can also be a very expensive way to buy, if you don’t use them sensibly.

Credit card interest rates are among the more expensive ways to borrow. Say you have a credit card with a 24% APR. If you use it to spend £1,000 (and don't spend further), then you repay the 2% minimum each month, it will take you 10 years and 11 months to clear the balance! Plus, you’ll have paid a whopping £1,619 in interest.

With a monthly repayment of £30 a month, you would be able to clear the balance in 4 years and 4 months, and save yourself £1,073 in interest charges.

3. Borrowing cash on a credit card

Borrowing cash on a credit card is not a good idea. You'll usually see a warning on the ATM when you try to do this notifying you of the potential fees. As well as the interest you'll be charged, you could find yourself paying additional fees or penalties for exceeding your credit limit or missing a credit card payment.

Credit and debit cards work differently at cash machines. If you withdraw cash using your credit card, this is usually called a 'cash advance' - you will pay interest immediately, even if you pay it off in your next bill. You may also have a higher APR rate for cash advances than for normal purchases. This includes taking out foreign currency cash overseas on a standard credit card.

Debit cards are mostly free, or tell you if there is a charge to withdraw cash. However, if you use your credit card to make a withdrawal then you may pay a fee every time, and you might not be given an on-screen warning. Fees can be as much as £5 per withdrawal.

4. Missing payments

If you make your payment after the monthly deadline on your statement, you may have to pay a late payment charge. Any 0% or other introductory interest rate you were paying is likely to be withdrawn, so you'll pay a higher rate going forward. Missed payments or non-payments are noted on your credit report, which can make it difficult for you to get other credit or loans in the future.

To avoid this pitfall, you should set up a direct debit to meet your monthly payments. At the very least you need to ensure that you make the minimum payment each month. However, in the long-term you'd be better focusing on clearing the entire balance each month to avoid any interest charges.

5. Falling into the 0% rate trap

Almost half of people who borrow on a 0% interest credit card fail to repay the balance before the deal ends and end up paying hefty interest charges. To avoid this, make a note of when the 0% rate ends and calculate how much you need to repay each month to repay the debt in full by that date. This way you’ll get the best of both worlds, without any nasty surprises at the end.

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