Here are the top ten things to consider when working out the best way to fund purchases, and how to make a credit card or loan work best for you.
1) Check your credit file
If you’re looking at either credit cards or loans you should do a little research into your score before applying. A low credit score can impact your chance of getting access to credit. Often the best deals on both are only available to those with the highest credit scores.
Remember that too many applications – for cards or loans – can make your credit score worse and minimise your chances of a successful application. You can use a ‘soft search’ to determine your chances of being accepted for credit products. Most providers offer this online and it only takes a few minutes.
2) Keep up to speed on the what’s happening in the market
Before committing to a credit card or loan, research the products available to find the most suitable for your needs.
For example, balance transfer cards are credit cards that can work to consolidate existing debts from current cards or loans into one. Many offer more than a number of months or years interest-free to help you pay off existing debt. However, do watch out for transfer fees. These are typically around 3%, so if you’re transferring a debt of £1,500 you could pay £45 to move the balance.
Other popular options are interest-free purchase cards. These provide an agreed amount to spend upfront without incurring interest. Other options allow you to set your own repayment schedules for specific items, to help plan when you’ll be able to clear each specific balance.
If you are looking to borrow a larger amount, the ability to repay the debt by making regular monthly repayments via a personal loan may be more appropriate.
3) Get clued-up on interest rates and charges
Once you have an idea of the essentials, compare the different options according to the specific terms and conditions.
For example, are there any administration fees or early-repayment fees? Familiarise yourself with interest rates too.
For loans, work out how much extra you’ll have to pay by considering the interest rate and your repayment schedule – there are calculators available to help you do this.
If you miss payments, the interest you owe will usually increase daily until the amount is paid.
Likewise, if you’re using a credit card, making every single repayment on time can be vital if you want to keep promotional rates (like interest free periods). If you don’t, you’ll often pay penalty charges and possibly revert to a higher interest rate. Also, if you make any additional purchases on an interest free card, your interest-free amount will be paid off first, leaving you paying interest at higher rates on more recent purchases.
4) Make a monthly budget
Before taking out any credit card or loan make sure you properly review your monthly incomings and outgoings to determine how much you can realistically afford to repay, and base your borrowing decision on this.
For instance, to make an attainable monthly budget, tot up your monthly spend, factoring in rent or mortgage payments, food, bills, travel costs and insurance policies etc. Also remember to account for annual events such as birthdays, holidays and car MOT’s.
Once you have an idea of your current budget – including any existing debt repayments – you’ll be able to work out how much you might be able to afford to repay on top of this.
It may be worth speaking to your bank about your options first, as they may be able to help advise you of the different costs and benefits of using credit. You could ask for statements from your current account over the last six months or year to help jog your memory.
5) Plan your purchases
When planning any project or purchase that might involve borrowing money, try to be realistic on the potential costs. It’s natural to want to keep budgets down, but an unrealistically low budget can lead to over-spending or running out of money.
Many larger expenses like a new kitchen tend to involve unforeseen circumstances that don’t become apparent until work has started. By factoring in a contingency of about 10%, you’ll get a clearer idea of how much you’ll realistically need to borrow in the first place.
6) Plan your borrowing period
Once you’ve decided how much you’re considering borrowing in total, you can then work out how long you’ll need to borrow for.
This should link to the spending you have in mind. For example, if you’re buying an annual holiday, you’ll probably want to repay in time for the next year – while a car might be expected to last for up to five years.
If you’re borrowing for something and hoping to pay it off quickly, you could take advantage of a 0% interest credit card, and pay off outstanding debt before the 0% interest period ends.
By contrast, if you’re not looking to pay off the borrowed amount in the near future, loans allow a longer borrowing period. For instance, a fixed interest loan allows you to choose upfront how many years you have to settle the balance, but also remember such loans often have early repayment fees if you do manage to pay off the sum earlier.
7) Create a month-by-month repayment plan
You might know you can generally afford to repay a given amount every month, but there will always be exceptional times – like Christmas, weddings, holidays or another as-yet unknown circumstance. So think about how to work around those trickier months, with a little extra set aside at other times to make up the difference.
Credit card repayments can be a more flexible option than loans – but the same principle of setting aside something extra in the easier months can be applied there too.
8) Weigh up the extra benefits
Some credit card providers reward you with airmiles or points from other reward schemes, so consider what each provider offers, and if you would use them. Often reward cards come with an annual fee which could cost more than the rewards you will be able to get back, so think about what these extras are worth to you.
Alternatively, you may find taking out a loan with your current account provider has benefits too. For example, if you’ve had a current account with the same provider for many years, they may offer you a better rate on the loan with them, instead of going elsewhere. But do check if fees apply.
9) Protect your purchases
You should consider what protection is on offer if something goes wrong with the purchase. For instance, credit cards offer a safety net on purchases over £100. Through Section 75 of the Consumer Credit Act, the law states that credit card companies are equally liable if there is a problem with a purchase. So, if you don’t receive your goods or services according to the terms of the sale you entered into, your card provider could help you get your money back.
10) Have a savings buffer
Take time to reflect on whether you have a financial ‘buffer’ if your circumstances were to change. This means emergency savings you could dip into. Would you be able to maintain repayments for a few months if you were in between jobs? Sometimes it can give you more reassurance to spend five minutes thinking through a more pessimistic scenario. If you have no savings, consider building a small savings pot before you borrow on credit.
Jon Roberts is head of cards at Lloyds Banking Group