Stop short-term need turning into a long-term crisis
As more Britons turn to credit cards long before the next payday, Chiara Cavaglieri investigates all the options
Sunday 17 July 2011
We all know money is tight but it seems things may be even worse than the headlines suggest, with a quarter of Britons forced to rely on credit cards to cover daily expenses.
It takes the average credit-card holder 21 days after payday to fall back on the plastic, according to Moneysupermarket.com. For one in 10 of this group it takes less than 15 days before their finances vanish and the credit card has to be called upon.
"It's no surprise to see so many people reliant on credit so early in the month. However, unless you plan this properly and know you're able to pay off your balance, this can be a dangerous trap to fall into," says Kevin Mountford, head of banking at Moneysupermarket. But is the credit card the best for short-term borrowing? What other options can to help you over those minor financial hiccups?
With an authorised overdraft, your bank offers you a safety net on your current account, up to a specific amount, to cover short-term cash-flow problems.
"If you need the money quickly, then an authorised overdraft could be a good option. Most banks can sort out an overdraft there and then if you meet their qualifying criteria," says Michelle Slade from Moneyfacts.co.uk.
Several bank accounts have an introductory interest-free overdraft. For example, Santander's current account offers a 0 per cent overdraft for the first year, but only for new customers. However, if you can't access the free overdrafts, be aware of high interest rates: Barclays charges 19.3 per cent and Lloyds TSB charges 18.9 per cent on their main current accounts.
"A number of providers have also moved to daily charges, which can soon add up. Halifax charged £1 per day on overdrafts up to £2,500 and £2 per day for larger amounts. With no maximum this could soon work out more costly," says Ms Slade.
If you borrow without the agreement of the bank, you could end up paying through the nose. Banks charge up to 30 per cent EAR, with penalty fees of £20 on top.
However, some current accounts do have a buffer zone, allowing customers a small window to go into the red without being charged interest or incurring fees. Unfortunately, the most generous buffer zones tend to be on fee-paying accounts such as the £500 buffer on the Citibank, Citigold account and Lloyds TSB Premier accounts as part of a package costing £25 per month. For fee-free accounts the Co-operative Bank current account plus is the least stingy, offering a £200 buffer.
Credit unions are a good alternative to the banks and will be a much cheaper way for you to borrow money than payday loans. They start from the premise of providing a mutually beneficial financial community to like-minded people. Members share a common bond such as working or living in the same area, belonging to the same church or trade union.
As a co-operative, members pool their savings in return for a reliable rate and that money is then lent out to other members at an affordable rate, with most charging no more than 12.7 per cent APR, the equivalent of repaying £1,067 on a £1,000 loan. Credit unions are far more willing to offer small loans ranging from just £50 – an area the high street banks aren't willing to touch.
However, if you are not yet an established member, you may not be able to borrow straight away. Credit unions are also unlikely to beat the best-buy credit cards and personal loans, but as these products are reserved for the most credit-worthy applicants only, they will be cheaper than many of the products banks offer to rejected applicants. Even better, credit union loans do not carry hidden charges and life cover is included. Find your nearest credit union on findyourcreditunion.co.uk.
Despite being described by some people as legal loan sharks, payday loan companies are increasingly popular with those struggling to make ends meet. The big pull here is the ease and speed with which you can get your hands on the cash. Companies such as TxtLoan, QuickQuid and Wonga offer cash advances from £80 to £1,000 straight into your account in a matter of minutes.
Much is made of the shocking interest rates which can exceed 4,000 per cent when converted to an annual percentage rate (APR), but this isn't always a helpful way to compare costs due to the short-term nature of these loans. If you borrow £100 and have to pay back £17 after 15 days, as with Txtloan, this actually represents an APR of 4,474 per cent, but in reality, paying back £117 could be cheaper than dipping into an overdraft.
While the rates may be slightly misleading, the danger lies in the way charges can spiral if you miss payments or decide to roll over the debt, as many companies encourage you to do. At TxtLoan, if you don't repay your loan on time, an admin fee of £25 is added on day 17 and again on day 27 and you pay interest at a rate of £1.13 per day. If you are still unable to clear your debt by day 46, they whack on another £47 fee and pass on the loan to a debt collector, by which time you owe £247.
"Payday lenders are very available and you typically don't need a credit check. They still represent a relatively small proportion of lending but there is a trend for people to borrow from as many as 20 of these lenders," says Delroy Corinaldi from debt charity Consumer Credit Counselling Service (CCCS).
Offset current account mortgage
If you want to maximise your savings but still have the option of access to it in an emergency, an offset mortgage may work for you. With these you link the balance of your savings and possibly your current account to your mortgage, so that you pay interest only on the difference. If you had a mortgage balance of £150,000 and £10,000 in savings, instead of getting a return on your nest egg, you offset it against your home loan so that you pay interest only on the £140,000.
Because you typically pay more interest as a borrower than you earn when you deposit money into a bank, this is a very efficient way to use your money. And if you're using your savings to trim your mortgage payments there is no tax bill to worry about.
Offset mortgages do tend to be pricier than mainstream loans, although that premium has fallen over the years and there are great deals around. For example, First Direct's interest-only base rate tracker, offered at up to 65 per cent loan-to-value (LTV), currently costs 2.79 per cent and allows unlimited overpayments.
If you have a good credit rating, a card with an introductory interest-free period will give you financial flexibility until payday. Tesco and Marks & Spencer offer 0 per cent interest for 15 months, with the bonus of Tesco Clubcard points or M&S vouchers.
These cards can be a helpful cushion if you find yourself struggling from time to time, but even without interest to worry about for 15 months you still need to pay at least the minimum repayment each month, typically 3 per cent of the balance, or you could lose the promotional rate.
Be aware that ATM credit-card withdrawals are charged interest from day one, typically at about 30 per cent and you'll pay fees of about 3 per cent.
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