USING THE VALUE IN YOUR HOUSE TO BORROW MORE

So you need a new car, or a conservatory extension on your house, or a new kitchen or bathroom. What is the cheapest way to borrow for these things?

Let’s imagine you have been living in your new home for a few years and during that time it has gone up in value by 30%. It’s now worth £260,000 compared to the £165,000 you paid for it. Your outstanding mortgage (taking account of what you have paid off on your repayment mortgage) is now only £130.000. You now have £130,000 of equity in the property and you can borrow against that added value by increasing your existing mortgage. This is by far the cheapest way of borrowing money for large items.

In these circumstances, your bank or building society lender will be delighted to lend you more money, provided you have kept up to date on your mortgage repayments since you took out your original mortgage. You should be able to get the increase on the same terms as your existing mortgage. If your lender does not agree to that and you are clear of the early redemption penalty period, shop around for a new lender. You may find a financial adviser as helpful as with the original loan. There will be plenty of lenders around offering to start a brand new mortgage for the whole of your existing outstanding mortgage plus the new money you want to borrow. And you can probably start a new discounted variable rate period too. Be careful, though, if you are benefiting from a fixed or capped rate mortgage where standard variable rates are already above the fixed or capped rate which you are paying. In these circumstances you will be better off agreeing to borrow the extra money you need from your existing lender at the higher SVR than giving up the benefit of your fixed rate or cap on what you owe already.

Before you switch from one lender to another for a better rate, check what set-up fees, legal costs and valuation fees you may have to pay. Some lenders will negotiate on these in order to get your business. When you think you have the best deals on the up front fees and charges, make sure that they don’t add up to more than any extra you will pay in interest over the remaining period of the loan if you stick with your existing lender. A good financial adviser will help you with the calculation.

PERSONAL LOANS

Perhaps you haven’t been in the house long, or house prices have not risen since you bought your house. If there is no ‘new equity’ in the house since you originally took out the mortgage, you are going to have to look elsewhere.

The next best deal you are likely to get is a personal loan.

Personal loans are made to people with good credit records. Because they are not secured on the borrower’s house, the lender will charge a higher rate of interest than they would charge on a mortgage loan. The lenders are relying on their judgement of your credit worthiness to get their money back. They will therefore carry out detailed checks with credit agencies, on your credit card record and on your current bank account. If there are problems you may not get a loan.

The high street banks are big lenders of this type and if you go to your own bank for a loan to buy a car or for a new kitchen or bathroom, this is the type of loan you are most likely to be offered. The interest rate (APR) may be at double and in some cases as much as four times what you would expect to pay for a mortgage. (So if you can raise the money through increasing your mortgage, you’ll be a lot better off doing that rather than taking a personal loan.)

The loan will usually be offered for a minimum of two years and there will not be an option to repay earlier (except possibly with a big penalty). Banks prefer to lend to you for as long as possible five or even ten years. The repayments are often front end loaded so that you will pay a higher rate of interest for the first two years than for the last three years of a five-year loan. The lender is encouraging you to keep the loan over the longer period. You will probably be offered a lower rate of interest if you agree to a longer loan period – but this will prove more expensive in the long run than a short term loan.

The temptation is to accept whatever your own bank offers you. If they don’t like the way you’ve run your account with them over the years (the occasional unauthorised overdraft perhaps), they may charge you more than their minimum rate. It is vital to shop around. There are very big differences in what different lenders will offer to the same borrower. There are also big differences in what one lender will offer to borrowers with varying credit records. If you borrow £8,000 over five years at an APR of 7.8%, you will pay £1,250 less in interest than if your lender charges you 13.8%. A few phone calls may find a lender who is prepared to charge you less because they think they can sell you other services. And they may not find out about that unauthorised overdraft you once had and which your own bank knows all about.

Don’t forget your other financial commitments though. Could you still pay your mortgage, your credit card and this new loan if you had a cut in overtime or bonus during the next three or five years? Repayment protection insurance is usually offered, but the benefits are very limited (similar to mortgage protection policies, see above). It’s also very expensive for what is offered. On a £10,000 loan, the repayment protection policy is likely to cost £300 per year.

CREDIT CARDS – YOUR FLEXIBLE FRIENDS

Credit cards are a blessing and a curse. They are a frighteningly convenient way to pay for almost everything you buy. That is not a problem if you pay off the outstanding balance every month.

The trouble is that the monthly statement tells you that you only have to pay off a tiny amount each month. If you are well inside your credit limit the amount they ask for is just a token – sometimes less than 1% of the outstanding balance. Like the drug dealers, they are trying to get you hooked. Before you are tempted to pay only the minimum, it is important to realise what a high rate of interest you are paying for this very easy form of credit. The problem is the confusion, often deliberately created by the banks issuing the credit cards, around the interest rates they charge. The Chief Executive of Barclays recently admitted to a Select Committee of the House of Commons that he would advise his children not to run up debt on a credit card – it was much too expensive a way to borrow. Take the advice of someone who knows! A huge variety of cards are very heavily advertised through the press and through direct mail, quoting different interest rates.

• Interest rate on credit balance transfers. The interest rate quoted by different companies ranges from 0% -yes really! – to 3 or 4% above base rate. But this low rate applies only to the debt you transfer from other credit cards, and then only for a limited period six to nine months is the usual maximum. This is the bait on the hook.
• Interest rate on new purchases. This is the rate you will pay over the long term and is much higher than the other rate – often 10 or 14% above base rate. That means you will be paying a rate of interest between three and four times what you pay for your mortgage.
• Interest rate on cash withdrawals. Some card issuers charge a higher rate on the part of the balance arising from cash withdrawals. There is also a fee for cash withdrawals – usually 2% of the amount withdrawn.

So if you are tempted to pay the minimum when your credit card statement arrives, ask yourself:

• Do you really need to borrow using your credit card when most other forms of credit are cheaper?
• If you do – remember to shop around for the card with the best rate. It will be worth changing as there are big variations in the rates charged.
• You will get the first few months after you switch card at a 0% or low rate on the balance you transfer. If you have the time and energy you might get away with switching a couple of times a year. Eventually you will have to pay the standard rate. Make sure you end up with the card with the lowest rate for new purchases.

Other points to remember about credit cards

• There is no need ever to pay an introductory or annual fee for a credit card.
• There are big penalty fees for not paying off the minimum monthly balance.
• If you are virtuous enough to pay off your balance in full every month, make sure you do it in plenty of time. Allow for postal delays. If you miss the date you could end up paying the penalty for missing the minimum payment as well as the interest on the balance. It is particularly easy to miss a payment when the statement comes in while you are away on holiday. The best plan is to go for a card which gives you the option to pay off the whole balance every month by direct debit from your bank account.
• If you use your credit card overseas, the rates of exchange used to calculate the sterling figure charged to your statement can vary. The card issuer may use a poor rate of exchange – or the rate may change between the day of purchase and the day the rate conversion is calculated. If you really need to know how much you are paying for something at the time you buy it, use cash or travellers’ cheques.

HIRE PURCHASE

When you buy a car (particularly a secondhand car) or an expensive domestic appliance, the garage or store may try to persuade you to enter into a hire purchase agreement. The salesman will make more on selling you the hire purchase agreement than on selling you the car or appliance and so will be very persuasive. Unless you are unable to get an increase in your mortgage or an unsecured personal loan, you would be wise to avoid hire purchase. The interest rate will be higher than you would need to pay for a personal loan and the car or appliance will remain the property of the hire purchase company until all the payments have been made. If you default on the payments before you have paid one third of the amount owed, the hire purchase company can recover the goods, and you are still liable to make the remainder of the payments if there is a difference between the proceeds of the sale of the goods and the outstanding debt! If you have no alternative source of credit and are thinking of signing the hire purchase agreement, read the small print very carefully before you finally decide.

STORE CARDS

These operate in a similar way to credit cards, but use of the card is restricted to the chain of stores issuing the card. No cash withdrawals are available. The main difference between store cards and credit cards is the rate of interest charged. It is a rip off. For most of the best known store chains the rate is nearly double the APR charged on the more competitive credit cards. If you have a store card, pay off in full every month – by direct debit if possible. If you can’t do this, use a credit card instead. And if you are up to your limit on your credit card, you are probably spending too much for your income anyway. So stop spending.

‘FREE CREDIT’ IN SHOPS

Yes, that’s what it says on the windows and in the advertisements. But remember the most important pieces of financial advice ever given - ‘If something looks too good to be true – it probably is’, and ‘There is no such thing as a free lunch’. Likewise, there is no such thing as ‘free credit’. You will always end up paying for it. Here are some of the games that retailers play:

• Putting the cost of the free credit into the price of the goods.
• Where the ‘free credit’ is for a limited period, you pay a higher rate of interest than the market rate when you do start paying. There are often penalties for early repayment so you have to pay the higher rates for a fixed period even if you could afford to pay off the loan.
• Charging big penalties if you fail to start paying when the free credit period ends. Often no reminder is sent out until it’s overdue. You might have forgotten or you might have run into hard times since you bought the goods two years earlier.
• Some shops might use a combination of all three of these.

How can you avoid being ripped off?

You might think that the obvious way is to pay cash up front and ask for a discount instead of ‘free credit’. You might be lucky and find a shop with a salesman who will take you up on this offer.

But don’t bank on it! Salesmen in shops offering these types of deal get a small basic salary. They make most of their income on selling credit agreements and insurance contracts for after sales breakdowns and maintenance. They will be disappointed if they’ve made a sale and then find you don’t want the deal which will bring them the really juicy commission. If you do decide to go for the free credit, read the small print very carefully, and work out what the real cost of the payments of the ‘free credit’ deal are. Then go out and see if you can get cheaper credit elsewhere – perhaps from a personal loan.

’I haven’t got time to do that’, you might say. Think about this. If you can get credit at a rate just 2% cheaper than the deal you are being offered at the store on a £2,000 item, you’ll be saving £120 on a three-year credit deal. How long would it take you to earn that after tax and national insurance? Even if you are earning £20 an hour gross, it will take you eight hours to earn that £120. It won’t take you anything like as long as that to ring around a few banks.

CATALOGUE CREDIT

Catalogue credit, like store credit, can look attractive. There is often an interest free period for repayment of up to a year. You will be repaying by instalments during this period, but not paying interest on the outstanding balance. But like the stores offering interest free credit, you are paying for it through the prices of the goods. Let’s be fair. Catalogues provide a very convenient way of spreading the cost of buying essentials like clothes and household goods and things for the children – particularly at Christmas time. You may have no alternative to mail order. Perhaps you can’t get out or you live in a very rural area a long way from big stores. In which case, take advantage of the free credit – you are paying for it anyway.

But remember:

• If you go beyond the free credit period you will be paying around 30% APR on your outstanding credit balances.
• If you miss repayments during the free credit period you will lose the free credit deal, have to pay penalty payments and pay a high rate of interest.
• If you take orders for friends and relations you are taking the risk and cost if they don’t pay up.

If you don’t need the convenience of catalogue buying, then you will probably get better prices and a better overall deal by shopping around in department stores and specialist shops and paying cash up front.

OTHER TYPES OF CREDIT

Credit Unions

Not many people know about Credit Unions. They are usually small and local organisations run on co-operative lines whose purpose is to make small loans (no more than a few hundred pounds) to local people. Interest rates are low and the aim is to lend to people who have difficulty getting credit on reasonable terms elsewhere. Each Credit Union has limited capital reserves and can only loan out new money as old loans are paid back. If you have a local Credit Union and they have money to lend, it’s the best deal you are likely to get anywhere. Your local Citizens Advice Bureau can tell you how to contact them.

Door-to-door credit

Beware! This type of credit is aimed at people who are unable to get credit from anyone else. But unlike Credit Unions, the companies involved are not there to help such people. They are there to make money.

Some are reputable companies. Others are plain and simple loan sharks operating on the very fringe of the law. The problem is telling one from the other. In any case, reputable or not, the companies charge interest rates which are extortionate. The trouble is, because the amounts lent are small, the interest charges don’t sound much to people desperate to get money to pay the rent or similar. But the actual APR can be anything between 100% and 1,000% p.a.

Agents go door to door to make the loans and collect repayments. However bad things seem, this type of loan will only make them worse. Don’t get involved!

INTEREST RATES – SOMETHING TO THINK ABOUT

We have talked a lot about interest rates – especially SVR, APR and base rate. Unfortunately interest rates are even more complicated than we have described so far.

We just need to mention the little problem of real and nominal interest rates. You won’t ever see them advertised, but it is important to understand the difference.

You pay interest as a penalty for having something now which you are not going to pay for until later. That seems fair enough. But you are also paying back the lender for taking the risk and (in the case of the last 60 years) the certainty, that when they get their money back it will not be worth as much (or buy as much) as when they lent you the money.

For example, if you are paying an interest rate of 5% on your mortgage (the nominal rate) and inflation is 2% p.a. – the real rate of interest is only 3% p.a. That doesn’t sound a lot. But on a personal loan you might be paying 10% p.a. With inflation at 2% p.a. the real rate is 8% p.a. That is a very high real rate compared with some periods in recent times. In the 1970s for example, when inflation ran as high as 25% p.a., mortgage interest rates were at record highs of 15% but the real rate of interest on mortgages at that time was minus 10%. Home buyers in this period thought they were really suffering because of these historically high nominal rates of 15%. Actually they were getting a real bargain. Lenders were paying them to borrow their money!

So always calculate the real interest rate to work out what you are really paying.

This might seem a bit theoretical. But it is important when you are worried about the amount of mortgage still to be paid off. When inflation and interest rates were both high in the 1970s and 1980s, the real value of your mortgage debt was shrinking fast while the money value of your house was going up fast. Those of us lucky enough to buy our first houses in the 1960s found that our mortgage was being paid off courtesy of high inflation. With the low inflation of today, the opposite is the case. High mortgage debt will stay high in both money and real terms.

Checklist

So if you need to borrow, here is a checklist which will help keep the bailiffs at bay.

Questions to ask all lenders

• 1.What is the APR?
• 2.What is the length of the loan period?
• 3.Are there penalties for early repayments?
• 4.Are there any set up fees?
• 5.Is the interest rate fixed or variable over the period of the loan?
• 6.Is the loan secured on your home?
• 7.Are there penalties for missed or delayed interest payments?
• 8.Are there any other charges of any sort whatever?

Questions to ask yourself

• 1.What am I borrowing this for: a long-term item (house, car, washing machine) or to help with current living costs?
• 2.How secure is my job over the period of the loan?
• 3.What does my total debt add up to after I’ve borrowed this?
• 4.Can I afford the interest and capital repayments on this total debt if: a) my overtime or bonus is cut, or b) my partner’s income is cut or disappears?
• 5.Is this the cheapest way for me to borrow for this purpose?
• 6.Is there another big item I am going to have to borrow for in the near future? How will this affect my ability to pay interest and pay back capital?
• 7.What is my long-term plan for getting out of debt?