Statistics from the Bank of England revealed that in 2019, consumers took up £13.2bn of additional credit debt. And according to the Office of National Statistics, close to 9 million people increased their borrowings in 2020 to help them cope with the covid pandemic. But there are a wide variety of ways people accessed this credit.
Data from the Financial Conduct Authority (FCA) shows that about 26 million Brits use overdraft facilities every year both arranged and unarranged. In a separate report, the FCA showed that on average, 36.9% of payday loan borrowers are people aged 25 and 34 years. The second highest age group of payday loan borrowers are people aged between 35 and 44 years, comprising 22.3% of the borrowers.
How Different Are the Credit Facilities in the Market?
Looking at the numbers, it is clear the appetite for credit in the UK, whether consumer credit or mortgage lending, is continuing to grow. With new financial products being rolled out and the traditional ones being tweaked to cater to the different consumer segments, it helps to know how these products are structured and their suitability to your circumstances. This article looks at lines of credit, bank overdrafts, credit card debt and payday loans.
Lines of Credit
A line of credit refers to a form of debt where a lender makes cash available as and when the borrower needs it. It is pre-approved credit that you draw upon as required. There is a maximum amount you can draw, and interest begins accumulating immediately you make your draw.
The main advantage of this form of credit is that it gives you flexibility on the amount to borrow and when to borrow. Lines of credit can either be secured or unsecured. Secured lines of credit use collateral such as a savings account or a property to guarantee repayment of the facility. Unsecured lines of credit on the other hand are mostly used by individuals and don’t require any collateral.
Lines of credit are priced based on Annual Percentage Rate (APR) which gives you the true cost of credit. If you have a good or excellent credit score when applying for a line of credit, you may qualify for a lower APR.
As an example, if you borrow from Drafty £1,200 for a year and your APR is 89.7%, you’ll repay the amount advanced plus an interest amount of £401.40 bringing the total to £1,601.40.
When you draw more than your bank account balance, you’ll end up with a bank overdraft. As a credit facility, the bank overdraft can be arranged where you notify the bank in advance before ‘going overdrawn’.
The bank will then authorise the overdraft facility and charge interest on the amount of the overdraft subject to a certain limit and period. In other cases, the period limit may be lifted, and interest calculated each day based on the days the overdraft is outstanding and charged to your account monthly. On average, expect to be charged up to 75p a day on a facility of £500.
If your account becomes overdrawn without you first having agreed on this with the bank, then you have an unarranged overdraft. The danger with an ‘unauthorised’ overdraft is that it will impact your credit rating and you will be charged a penal rate of interest and potentially additional fees.
If you get an arranged overdraft of £1,200 for 30 days at 35.0% APR Representative (variable), you’ll pay about £29.87 in interest.
Bank overdrafts require that you have a bank account before applying. The bank will ask you to declare your net income each month, any other credit arrangements you have, and your monthly expenses.
When borrowing for short-term needs (up to a month) and amounts not exceeding £5,000, bank overdrafts can be an option. That being said, check for overdraft facility fee as it can be quite substantial.
Credit card debt is one of the most common forms of consumer credit in the UK. Whether you want to bridge your cash flow or help pay for essentials, credit card debt is among the preferred forms of financing.
Balance transfer credit cards -these cards help in consolidating what you owe from other cards so you can transfer the balance onto a new card.
Purchase offer credit cards -these types of cards don’t charge interest and are best used for shopping.
Reward credit cards – if you want to pocket cashback, on your everyday spending reward credit cards will give you exactly that.
Credit building credit cards – whether you are building your credit score from scratch or improving it, credit building cards can help.
The variety of features in credit cards is what makes them among the preferred form of consumer credit. Having said that, balance transfer cards only make economic sense if you take advantage of the 0% introductory interest for the stated period or transfer a given minimum within the duration given such as 60 days after opening your account.
There are also transfer fees to factor in ranging anywhere from as low as 0.9% to about 3%. The representative APR for most credit cards is around 21.9% and if you pay the balance within 26 months, you could be charged interest of about £50- £60.
Payday loans are short-term credit facilities that can get you approved for amounts ranging from £100 to £1000. The FCA has been very strict on payday loans following claims of high APRs that can make them unaffordable. However, most lenders are working to ensure the borrower concerns raised are addressed.
The advantage with these loans is that they are approved almost instantly and transfers are made virtually instantly giving you quick access to cash. For instance, if you borrow £300 for a period of 3 months, the interest that you’ll pay is £154.37, bringing the total amount payable to £454.37. The APR can be as high as 1301%.
Amanda Gillam is Solution Loans's General Manager and has been since 2009. She is also a prolific writer on personal finance issues, and has been quoted numerous times in articles published on 3rd party websites and in press releases. Her...Read more about Amanda Gillam