Personal Finance - Unit 5 - Borrowing Money

Personal Finance – Borrowing Money Introduction In this unit you will study the following things about borrowing money so you pay as little as possible for it.

Loans – can you afford the repayments Interest rates Credit rating Types of credit Problems with debt.

Assessment At the end of this unit are six multiple choice questions. You need to get four out of six correct to pass this unit.

Borrowing money This is using someone else's money as your own. You need to pay it back though.

Loan & debt Loan – This is what the bank gives you. Bank plc gives you a £1,000 loan.

Debt – This is what you owe - £1,000.

Reality check - Captain Sensible Try and think about what you can afford.

Remember you need such stuff as somewhere to live and it's nice to be warm and have some food to eat and go out with friends and enjoy yourself.

You need Rent Heating Food Clothes Fun.

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Budgets Have a look at this person. S/he’s got a flat and is working. S/he'd like to get a loan for a car. Here's what s/he spends each week.

S/he earns £230 a week, that is £11,500 per year.

Item Rent Gas Electricity Water Insurance Council Tax Phone Costs Savings Travel Costs Food and Household TV licence (it is illegal not to have one if you have a TV) Total

Cost £85 £10 £10 £4 £3 £15 £7 £5 £25 £50 £3 £217

Activity 1 Do you think s/he could afford to pay back a loan for a car and run a car as well?

(The answer’s on page 6.)

Yes No

The banks and lending you money Lending you money makes profit for them.

Banks etc earn money by charging you interest on money you borrow from them.

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Not just banks Finance companies, store cards and even door-to-door salesmen all make big profits from lending you money - a loan.

Payback time What you borrow must be paid back with interest.

The interest = their profit.

Islamic law and money Basic principle Based upon Qur'an and Sunnah - making money from money is NOT allowed.

Interest not allowed Most Western bank accounts and mortgages do not comply with Islamic Sharia law.

Partnership Customers and Islamic banks both share in the risk and the profit from any investment. This is based upon a written agreement.

Ethical Islamic banks will not invest in such things as: Alcohol Gambling Pornography.

Learn more If you want to learn more then Google “The Islamic Bank of Britain�.

Other banks such as Lloyds Banking Group and HSBC have Islamic sections to their banks.

Percentage % interest The higher the percentage interest you pay for a loan the bigger the profit for them.

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There are two abbreviations which you need to remember APR – interest rate on borrowing money AER – interest rate on savings

APR (borrowing) = annual percentage rate This is the full cost of the interest you will pay including any set-up fees etc.

The law states you have to be given this figure so that you can compare different loans on the same basis.

AER (saving) = annual equivalent rate This is the full amount you get from the Bank for saving with it. Some banks pay interest weekly, monthly or yearly. The AER shows exactly how much you get and means you can compare them to get the best rate for your money.

Shop around The lower the percentage APR you pay the less you will have to pay back.

Two types of interest Fixed rate of interest Variable rate of interest.

Fixed rate of interest Fixed - the interest rate stays the same no matter what happens.

Variable rate of interest Variable - the interest rate changes over time. It can go up or down.

Why do interest rates change?

Banks change their interest rates for borrowers and savers mainly on one thing: The interest rate set by the Bank of England.

This is called the Base Rate.

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Bank of England You cannot go to London to get a loan from the Bank of England.

However, Banks etc can.

So if the Bank of England changes its interest rates it then affects what the banks charge borrowers and give to savers.

Up and down It can go up and down depending upon the rates set by the Bank of England.

Fixed rate of interest If you fix the rate of interest with the Bank at 10% (per cent) APR that's what you'll pay whatever happens.

Good and bad If interest rates rise to 15% you will still be paying 10% interest – great.

But If interest rates fall to 7% you will still be paying 10% interest – rubbish.

Example If you look at the graphic you will see that mortgage rates came down from 8% in 2007 to 3% in 2009. So if you had fixed your mortgage in 2007 you would be paying a lot more money now.

Variable A variable rate of interest (a rate that can go up or down) would have been better.

But As no-one can predict the future it’s really difficult to decide what’s best.

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Activity 2 A lot of people shop around for the cheapest electrical goods but tend not to bother when it comes to getting a loan. Select TWO only. (The answer’s on page 7.)

They really like paying extra Financial products can be confusing Financial products can be boring There’s no difference between financial products.

Carefree spending Some people just love spending money. They need the latest stuff. They forget they have to pay it all back plus the interest.

Debt problems If you owe the bank money they're going to get it back from you. They are really well organised to make sure you pay up.

Activity 3 You have a variable rate loan from the bank to buy a car. The interest rate you are paying now is 18% (per cent) variable.

Can the interest rate change? (The answer’s on page 9.)

Yes No

Answer Activity 1 Correct answer. No. Feedback: Correct answer: Well done. There's very little that s/he can cut down on. So s/he would struggle to pay back the loan and run a car and if the car broke down……

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Why we borrow The usual reason The usual reason is obviously because we've not got enough money.

Too much money Houses etc are often so expensive that you could never save enough to buy one so we need to borrow - a mortgage.

Something happens Your best friend gets married in Italy.

You need a deposit for a flat or you start a new job in another town.

You've no savings so you need to borrow.

Activity 4 Banks, finance companies and stores like you to borrow money from them because: Select ONE only. (The answer’s on page 10.)

They want to be as helpful as possible They have too much money of their own They make a lot of profit from it They make no profit from it.

Answer Activity 2 Correct answer: Financial products can be confusing Financial products can be boring They don’t shop around because financial products can be confusing and boring

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2 Basic Loans - two basic types of loan are: Secured loan Unsecured loan

Secured loan The bank lends you money to buy a house or a car. If you don't pay them back they take the house or car from you. The loan is secured on the VALUE of the house or car. This can also be called “A charging order”.

Graphic of house with the word, “mortgage” secured to it.

Unsecured loan The bank lends you money. If you don't pay they can only apply to court for an order for you to pay up. The order can allow bailiffs to take some of your stuff and auction it.

Risk What’s your credit rating?

The bank manager has to work out whether you can pay back the loan.

These are some of the things s/he might ask you: How much money you earn How much you spend Do you have any savings Have you anything of value if you can't pay How would you pay back the money?

Now Since the credit crunch banks are really careful about to whom they lend money. If they think you're are a poor risk they'll do two things: Not lend any money to you Charge you loads for a loan (high %APR).

Low-paid job - an example If you're a low-paid worker and have no real savings you'll find it really difficult to get a bank loan. The bank won't feel you can pay back the money.

However, credit unions (which are covered later) could be really good for you.

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Four different types of credit Four types The four different types of credit will be looked at in the next few pages.

Cheapest forms of credit

Expensive forms of credit

Very expensive forms of credit

Illegal and dangerous forms

Credit Union

Store Cards

Doorstep credit sellers

Unlicensed loan sharks

Bank loan

Overdraft

Pay day cheques

Web based money sharing schemes

Credit card

Cheque cashing services Pawnbrokers

Activity 5 There are two basic types of loan, what are they?

Select ONE only. (The answer’s on page 11.)

Floating and non-floating loans Secured and unsecured loans Mobile and static loans Digital and terrestrial loans.

Answer Activity 3 Correct answer. Yes A variable rate of interest CAN change. A fixed rate of interest CANNOT change

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Cheapest forms of credit 1) Bank loan This is one of the cheapest ways of getting money. You can apply to any bank.

But they only lend money to people who are a very good credit risk.

2) Web based money sharing schemes – new and different ZOPA is the market leader for this. Internet only. It looks like a social network site for money but really it’s a bank for profit. It has no branches and says it’s cheaper than a bank loan. But they only lend money to people who are working and are a good credit risk.

As it’s such a new form of borrowing, there’s a long description of it at the back of this unit (page 104). www.zopa.com

3) Credit Unions (simply the best) These are usually the cheapest ways for people to get a loan. They usually offer the best deals by far. And they're particularly good for poorer people because they are not businesses like banks and do NOT make a profit.

Answer Activity 4 Correct answer. They make a lot of profit from it Feedback: Correct answer: Well done. Banks etc like you to borrow money from them because they make a lot of profit from it.

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Expensive credit 1) Overdraft This person’s wages are too low for his/her wages. Hence s/he has gone overdrawn or into the red in his/her account. The bank will charge a high % APR for this as well as a likely penalty fine.

Bank Statement Income Wages 27 May

Total income

Expenditure £180

Rent 1 June

£100

Gas bill 2 June

£50

Electricity bill 2 June

£49

The Good Night Out Company Ltd 2 June

£20

Total expenditure

£219

Balance

-£39

£180

2) Store card You can only use these in the ONE store. They usually have a high rate of interest - often much higher than a bank loan or even a credit card.

3) Credit cards These usually involve high interest rates and can be complicated. They often have sneaky hidden charges.

Answer Activity 5 Correct answer. Secured and unsecured loans The two basic types of loan are secured and unsecured loans

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Very expensive credit People on low incomes People on low incomes often use doorstep lenders, pay day advances and pawnbrokers which charge really high rates of interest (250% APR +).

This is because the banks won’t lend them money as they do NOT think they will pay the money back.

1) Door step lenders Some big financial companies operate “friendly sellers” who give unsecured loans at very high interest rates.

You can pay between 200% and 450% percentage APR interest.

2) Pay day advances & cheque cashing services (loans) These are very similar in that you will pay really high interest rates (450% +).

It won’t look expensive because they only lend you money for a few days or a couple of weeks.

3) Pawnbrokers You take an item of value to the pawnbrokers. They value it instantly. An amount of money is given to you. You pay more money back to reclaim what you've left with them. Supposedly 88% (per cent) of stuff is reclaimed.

Activity 6 Here’s a statement from a credit card company giving some of the terms and conditions of using their credit card.

Read it and answer the question below.

A penalty charge of £10 will apply on each occasion that: Your payment does not reach us by the last day of the month.

Your outstanding balance exceeds your credit limit.

How much extra will you pay, if your payment does NOT reach the credit card company by the last date of the month?

Select ONE only. (The answer’s on page 14.)

Nothing

£10.00

£6.00

£12.00

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Illegal and dangerous credit Licensed Anyone who lends you money and charges interest has to be licensed by law.

Unlicensed loan sharks Some people lend money and are unlicensed. These people work outside the law. They are nasty, vicious people. There's not a lot else to be said about them.

Advantages of using unlicensed loan sharks They work outside the law so you don't have, by law, to repay them.

Disadvantages of using unlicensed loan sharks Incredibly high interest rates AND walking could be a problem if you don't pay up.

Examples In 2009 Karl Gordon and Majid Tabassom were given long prison sentences for unlicensed money-lending and beating up a man whose debt had ballooned to £250,000. By the way they also threatened to cut his hand off if he didn't pay.

Paul Nicholson was found guilty in 2009 of blackmail, assault and rape. He made his money from unlicensed money-lending (loan shark). He lived in a 14 acre £1.5 million mansion.

Activity 7 One disadvantage of using an unlicensed money lender would be: Select ONE only. (The answer’s on page 15.)

Friendly and courteous service Low interest rates Home visits Extremely high interest rates and possible violence or threats if you do not pay

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Why are credit unions so good?

They are owned by their members. They are not a business in the sense that a bank is. Any profit they make is given back to their members.

Be a member You have to join the Credit Union to get a loan. They will not try to sell you stuff. They genuinely and honestly get you the best deal and give you the best advice free.

Half a million They're in most areas of the country but not all. They have half a million members in the UK.

Real stories Here’s a real life story about David (false name).

Not the usual suspect David was a policeman. He got in to debt so he used a cheque cashing service to get his money before pay day. They really charged him for this. He was getting deeper and deeper into debt. The Credit Union loaned him the money to pay off his debts. He had a good income so it was OK in the end.

But he could have lost his job if he'd got into more debt.

Activity 8 Which TWO methods of borrowing money are usually the BEST VALUE when you want to buy furniture?

Select TWO only. (The answer’s on page 16.)

Credit union loan Store card Bank loan Credit card.

Answer Activity 6 Correct answer. £10.

If your payment does NOT reach the credit card company by the last date of the month they will charge you £10.

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Golden rules People do not lend you money for fun or love.

Buy Financial products like you'd buy other stuff.

Small stuff Read the form and especially the hidden penalties etc Don’t be hasty Be prepared to: -

Walk away

-

Think about it

Don't be pressurised.

There may be penalties in the small print.

Activity 9 Which of the following would be THE MOST SUITABLE source of independent advice about comparing the cost of credit cards?

Select ONE only. (The answer’s on page 17.)

Local bank branch Advertisements in the newspaper Local Post Office Price comparison website.

Answer Activity 7 Correct answer. Extremely high interest rates and possible violence or threats if you do not pay Feedback: Correct answer: Well done. One disadvantage of using an unlicensed money lender would be that they charge extremely high interest rates and possible violence or threats if you do not pay.

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Hire purchase (HP) / Conditional sale It’s similar It’s credit and they have high interest rates BUT they’re very different in one way.

The main difference – the clue’s in the title Hire purchase means you are hiring (renting) the goods (TV etc) from the shop.

Not yours It is NOT yours UNTIL you make the final payment. Until then it’s just like you are renting it from the shop.

Example You stop paying the hire purchase agreement. The shop has a legal right to come and take it away from you even if you’ve only 1 more payment to make.

Answer Activity 8 Correct answer: When deciding whether to take out a loan to buy something expensive you need to think about 3 things: How you will repay the loan How secure your job is Whether the interest rate will go up.

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When things go wrong Stuff happens Here's a list of things that can affect you when you try to pay back the money you owe.

You lose your job - redundancy You get ill The interest rate you are paying goes up Something happens you've not planned for.

Real life story Here’s another real life story (false name).

In a mess Mary half owned the house she lived in with her husband. One day he beat her up badly and she quickly left the house. She needed a deposit quickly for a flat but the bank wouldn't give it. A credit union saw her need as important and loaned her the money. She got quickly settled in and started divorce proceedings. The Credit Union gave her more money for furniture. She paid them back when the house was sold.

Debt Four million people Did you know that about 4,000,000 (four million) people will go for some kind of debt advice THIS YEAR?

A plan Whatever has happened, you will need a plan.

Don't be an ostrich Debt gets bigger the longer you leave it. Get it sorted as soon as possible.

Answer Activity 9 Correct answer. Price comparison website.

The most suitable source of independent advice about comparing the cost of credit cards would be price comparison sites on the Internet

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Get help for free There are some really good free services that will help you if you get in a mess.

Activity 10 When deciding whether to take out a loan to buy something expensive you need to think about: Select THREE only. (The answer’s on page 19.)

How you will repay the loan How secure your job is Whether the interest rate will go up Whether there will be a general election.

Contacts and information Have a look at the list on the next page and use the one you think is best for you.

Where to get help and advice There's a lot of free help and guidance on money matters. Always get free, independent help before you pay for it.

Citizens Advice Bureau (CAB) You might think the name is a bit naff but it's dead straightforward and they REALLY, REALLY HELP. They provide free information and advice on legal, financial and other problems. You can find your local CAB in the phone book or on the CAB website. http://www.citizensadvice.org.uk/index/getadvice By the way, have I said they're really, really good and confidential?

National Debtline This is a telephone service to help you manage debt.

0808 808 4000 http://nationaldebtline.co.uk

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Consumer Credit Counselling Service (CCCS) It offers a free national telephone service on: Personal budgeting Credit cards Paying back debt.

Office of Fair Trading (OFT) The Office of Fair Trading is also really good and usually fairly local.

Here's the head office but check out your local place.

Fleetbank House 2-6 Salisbury Square London EC4Y 8JX Tel: 0845 7224 499 (public enquiries) http://www.oft.gov.uk

Credit unions ABCUL, Holyoake House, Hanover St, Manchester M60 0AS 0161 832 3694 www.abcul.org

Answer Activity 10 Correct answer: When deciding whether to take out a loan to buy something expensive you need to think about 3 things: How you will repay the loan How secure your job is Whether the interest rate will go up.

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Unit test Here are six questions about this unit. You need to get four out of six correct to pass.

Question 1) The main advantage of all borrowing is: Select ONE only.

Life insurance comes with all forms of borrowing It allows you to buy now and pay later Any debt is cancelled at retirement age You don’t have to pay interest at any point

Question 2) Which of the following is THE MOST USEFUL feature of a credit card?

Select ONE only.

Cheap way to borrow.

Flexible way to borrow.

Insecure method of borrowing.

Cheap way of getting cash from ATMs.

Question 3) What is the main disadvantage of using credit cards to manage your spending?

Select ONE only.

If you don’t pay the money back on time NO interest is charged Credit cards are very flexible You only pay off small amounts from your credit card each month It’s very easy to get in to debt with a credit card.

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Question 4) You buy a car using an UNSECURED loan from a bank. What can happen to the car if you don’t pay back the loan?

Select ONE only.

You will be able to keep the car You car can be taken away The bank will top up the loan You will not get insurance for it

Question 5) If you want to borrow money for a car which is MOST likely to offer the best deal?

Select ONE only.

A credit card with an APR of 26% (per cent) A door step loan from a licensed moneylender at 183% (per cent) APR A bank loan with an APR of 12% per cent An unlicensed money lender where you have to pay back £50 per week.

Question 6) Which method of borrowing money would usually give the LEAST VALUE when you want to buy furniture?

Select ONE only.

Credit union loan Store card Bank loan Building Society loan

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Web-based money sharing Bank but not a bank - ZOPA You can borrow money if you are in work from an internet organisation called ZOPA. This looks very much like a social network site for money. It's only been going since 2005. Its website looks excellent. It's only web-based; it has no high street branches. It only communicates by email.

How it works It works in much the same way as a bank does: Real people lend money and get interest from it Real people borrow money and pay interest ZOPA just transfers the money between the people.

Lending money It will only lend money to people who work and have good wages and have a good credit history. Summary ZOPA: Web based (email contact only) People offer money to borrowers People borrow money from lenders ZOPA organises the transfer of money.

Things that are the same Borrowers have identity checks and have a full credit history done by ZOPA. It says it uses the same companies that do this for banks. If borrowers do not pay back their loan they can be taken to court in exactly the same way as a bank does.

Credit rating A* A, B, C or Young ZOPA will give you one of these credit ratings when you apply for a loan. It's based upon things such as your income and whether you've had any bad debts in the past.

Interest rate The interest rate you will get will be similar (the website says lower) to a bank's personal loan interest rate. In general the worse your credit rating the more interest you will have to pay. So A* people get the best interest rate and C or Young get the highest interest rate to pay.

Secure The company, ZOPA, is backed by big American investors who also backed eBay and Skype. Their website may look cool and very user-friendly but remember they are there to make a profit.

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Charges It charges borrowers a ÂŁ118.50 fee for each loan. This is the fee that ZOPA charges for arranging the loan. The interest rate is extra to this.

Summary borrowers Only people in work Good credit history Credit rating shown Interest rate varies depending on credit rating

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Unit Test The answers are highlighted.

1)

The main advantage of all borrowing is: Life insurance comes with all forms of borrowing It allows you to buy now and pay later Any debt is cancelled at retirement age You don’t have to pay interest at any point

2)

Which of the following is THE MOST USEFUL feature of a credit card?

Cheap way to borrow.

Flexible way to borrow.

Insecure method of borrowing.

Cheap way of getting cash from ATMs.

3)

What is the main disadvantage of using credit cards to manage your spending?

If you don’t pay the money back on time NO interest is charged Credit cards are very flexible You only pay off small amounts from your credit card each month It’s very easy to get in to debt with a credit card.

4)

You buy a car using an UNSECURED loan from a bank. What can happen to the car if you don’t pay back the loan?

You will be able to keep the car You car can be taken away The bank will top up the loan You will not get insurance for it

5)

If you want to borrow money for a car which is MOST likely to offer the best deal?

A credit card with an APR of 26% (per cent) A door step loan from a licensed moneylender at 183% (per cent) APR A bank loan with an APR of 12% per cent An unlicensed money lender where you have to pay back £50 per week.

6)

Which method of borrowing money would usually give the LEAST VALUE when you want to buy furniture?

Credit union loan Store card Bank loan Building Society loan

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