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Working out a repayment plan for your borrowing

If you’re considering borrowing money, it’s important you think about how you’ll repay it. By understanding the true cost of your borrowing, you can make sure you’re getting the best deal and can make all the repayments.

What affects your borrowing costs?

Be aware that as well as paying back what you borrow, you'll also have to pay interest.

The interest rate you’ll be charged depends on several factors, including your credit rating, how much money you want to borrow and how long for.

If you want to borrow a small amount of money over a short period, you might be offered a low interest rate. If you want to borrow a large amount of money over a longer period, the interest rate might be higher.

However, this isn’t always the case. For example – very short-term loans, such as payday loans, can charge a higher rate of interest. Mortgages involve borrowing large sums over long periods, but because they’re secured against the property you’re buying, the interest rates might be lower.

If you want to compare the costs of borrowing, it’s important to use the Annual Percentage Rate (APR) to work out the true cost. The lower the APR, the less you will pay back.

Your lender should tell you the total cost of the loan you’ll be repaying, so you can work out how much you’ll repay in total compared with how much you borrowed.

Calculating the cost of borrowing

You can work out how much it will cost you to borrow using the information lenders have to give you.

By law, when you apply, they must tell you:

  • how much you’ll have to repay in total
  • how much you’ll have to pay every month
  • the interest rates, any fees or charges and the APR.

This information should be on the credit card or loan lender’s website. It must also be included in the pre-contract credit information form.

The firm must explain the main terms and conditions of the loan before you are bound by the contract.

In the case of credit cards, this will be based on certain assumptions about how you’ll use the card, such as how much you’ll be spending every month.

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How much can you afford to repay each month?

The only way to know for certain whether you can afford the repayments is to put together a household budget.

This will show you how much you have left over at the end of each month when you’ve paid all your bills and living expenses.

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Make sure you keep up with your repayments

If you miss any repayments, you could be hit by fees and extra charges.

Missing payments will also harm your credit rating. This is because lenders look at how you’ve managed your existing credit when working out your credit score. This might mean that you’ll struggle to borrow money in future or that you’ll have to pay a higher interest rate for future loans.

Are you worried about forgetting payments? Then setting up a regular standing order (for a fixed amount) or a Direct Debit can be a good way to make sure payments are always made.

But if your income changes from month to month, or you’re worried there might not always be enough money in your account, making manual payments might be the better option.

Borrowing options

Let’s look at an example. John needs to borrow £2,500 to replace his old boiler.

He gets a quote from a big energy company for the boiler and the installation,  based on paying back a loan after two years.

However, when he reads the contract he notices that if he takes out the credit for two years he’ll pay more than £300 in interest.

So John looks around for other options.

As he has a good credit rating, he considers:

  • taking out a credit card with an introductory interest-free period of 15 months on new purchases, or
  • applying for a personal loan with an interest rate of 10% he can pay back over two years.

This is how much John might have to repay each month and overall:

Option
Interest rate
Monthly repayment
Total amount repayable

Credit card over 15 months

0%

£166.67

£2,500

Personal loan over two years

10%

£115.33

£2,768 (£2,500 borrowed + £268 interest)

Energy company credit agreement over two years

30%

£139.75

£3,354 (£2,500 borrowed + £854 interest)

In the end, John takes a look at his monthly budget and decides he can afford to take out the credit card and pay the extra £26.92 each month to avoid having to pay any interest.

It means he’ll have paid off the balance in 15 months and he won’t have been charged interest.

John will only save money because he knows he can make the payments within the 15 months.

If you don’t think you would be able to do that, a credit card could cost you more.

What this table shows is the difference in repayment plans over different periods of time, and how being able to pay a little more each month might mean you’re able to take out a much cheaper form of credit.

It also highlights the importance of shopping around for credit and not just taking the first product you’re offered or always going for the lowest monthly repayment.

Regular versus flexible payments

A loan agreement will tell you an amount you have to pay back every month.

Repaying your loan early at any time, in full or part, can be a good way of minimising cost. And loan providers must allow you to pay back a personal loan in full, but it can come with an early repayment charge of around one to two months’ interest. Any fees and how they’re calculated should be set out in your loan information and agreement, so you know what to expect if you repay early.

Some lenders advertise that you won’t pay an early repayment charge (ERC) or fee if you pay off your loan sooner than agreed. But it’s likely that you’ll still be charged up to two months interest on whatever sums you repaid early.

By law, almost everyone who took out loans from February 2011 onwards can make partial or full early settlements of up to £8,000 a year before being hit with penalty fees.

If there's more than a year left on the loan repayment period, when more than £8,000 has been paid off, the maximum penalty charge that can be levied is 1% of the amount being repaid early.

If that kind of overpayment is made in the final year of the credit agreement, the penalty can’t exceed 0.5%.

Ask your lender for a ‘settlement statement’ showing how much you’ll save by repaying early.

Other forms of borrowing might be more flexible, with low or no minimum repayment.

But the interest rates on these can be very high, so that the amount you owe can quickly increase. If you have a large overdraft, it might be best to try and secure a cheaper loan to pay it off and make regular payments to repay this.

It's important to be wary of paying only the minimum repayment on a credit card – always try to make larger payments to pay the actual amount you owe every month.

Credit card providers are obliged to contact people who have paid more in interest, fees and charges than the amount they have paid against their actual purchases over the last 18 months.

This is where you’ve paid more in interest, fees and charges than what you’ve paid back to get the balance down on your credit card.   

Lenders are required to suggest higher affordable repayments. If you don’t respond, or ignore the issue, and the situation persists for more than 36 months this could lead to your account being suspended.  

Regular repayments

Pros
    • Repaying a regular fixed amount might help you budget.
    • You know exactly when you have repaid what you owe.
    • You should be able to repay your loan early with no penalty (or early repayment charge).
    • You’re likely to pay less interest overall and repay the amount quicker.
Cons
    • If your income fluctuates you might find it harder to make regular payments.
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Looking for us? Now, we’re MoneyHelper

MoneyHelper is the new, easy way to get clear, free,
impartial help for all your money and pension choices.
Whatever your circumstances or plans, move forward with MoneyHelper.

Continue to website
Looking for us? Now, we’re MoneyHelper

MoneyHelper is the new, easy way to get clear, free,
impartial help for all your money and pension choices.
Whatever your circumstances or plans, move forward with MoneyHelper.

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