Whether it’s for a big goal like buying your first home, getting a new car or starting a business — at some point in our lives most of us will look to borrow money. But for those of us who have never done so before, the world of credit can be very confusing. That’s why we created this complete beginner’s guide to borrowing money; to help you out by making it easier to understand. Let’s dig in.
Why borrow money
When an agreement is reached between a lender (like a bank) and a borrower (like me or you) over an amount of money the borrower can borrow from the lender, in what way (ie lump sum or instalments etc) and on what repayment terms (ie interest rates and frequency of repayments etc) — this is referred to as a credit agreement. In fewer words, a credit agreement is the mechanism through which people borrow money from financial institutions.
Rather than waiting a long time to make a purchase by saving up the money you will need to buy it upfront, borrowing money (or ‘arranging credit’) gives you a way to buy it sooner than you could otherwise by paying for it with someone else’s money.
Of course, borrowing money comes with a cost. This is usually charged in interest rates, though there can also be arrangement fees and/or other further charges. What this means is that borrowing money is a more expensive way to pay for something in the long run than paying for it out of savings would be. So should you do it?
Should you borrow money?
Debt is neither good or bad. And while not having debts to pay off affords you a certain level of freedom and flexibility in managing your income, there are big purchases in life where if you saved up enough to buy the thing outright, it would make doing so a lot harder. Sometimes impossibly so.
One example is buying a house. Average house prices in the UK are now £267,000 in England, £179,000 in Wales, £164,000 in Scotland and £148,000 in Northern Ireland. So for most people saving up enough cash to buy a house outright might take most of their lives.
Mortgages are loans specifically for buying property. Compared to other types of loans and credit agreements, mortgages tend to let you take on debt at more affordable rates. This debt makes sense for many people because otherwise owning a home might not be possible….at least not for a really, really long time anyway.
Just remember that with any financial decision or arrangement, it’s important to know what you’re doing with your money and to be on top of managing it.
Ways to borrow money
There are lots of ways to borrow money. Here’s a quick summary of some of the main ways.
Loans are the best option for borrowing when you’re looking to fund a bigger one-off purchase like a car.
You can use credit cards in lots of ways. Be that for regular everyday spending, bigger one-off purchases like a holiday, balance or money transfers. Some credit cards also offer incentives like cashback or other rewards. However, credit cards are better thought of as spending tools, rather than borrowing tools. Borrowing on credit cards (when you spend and don’t pay off the balance in the same month) is usually a very expensive way of borrowing.
A mortgage is a loan specifically for purchasing property or land.
An overdraft is an option often used for short term borrowing. Particularly in situations when money is needed quickly for things like unexpected bills and everyday spending.
How much can I borrow?
How much money you’re able to borrow will depend on your financial situation and the lender’s risk appetite. When reviewing your financial situation lenders may look at: how much you earn, your lifestyle and expenses, how much debt you have, your credit history and a number of other things. They will use this information to check that you meet their eligibility criteria and to calculate what repayments you can afford, otherwise known as your affordability.
A lender’s appetite for risk depends upon what’s currently going on in the world and the financial markets. During times of economic uncertainty lenders worry about whether the people they’re lending money to will become less able to pay them back (whether this is because they’ve lost their job or because of rising prices).
That’s why during the pandemic mortgage approvals fell as uncertainty reduced lenders appetite for risk. Lenders tightened their lending criteria too during this time, with many no longer offering products like 95% mortgages. (However, 95% mortgages are now being reintroduced following the launch of a new government scheme aimed at helping first-time buyers.)
How to borrow money
Borrowing money to finance a purchase isn’t a decision that should be made lightly. Paying it back over time is a big commitment after all. But if after thinking about it long and hard, you’ve decided this is the best option for you, here’s what to do next:
1. Check your credit reports
When gearing up to arrange credit, an important starting place is checking your credit reports. Your credit reports contain many things but lenders are particularly interested in the overview it gives of your historic experiences in borrowing money and your track record in paying it back (ie did you make payments in full and on time). If you’ve never borrowed money before this can cause a problem for you as you may be regarded as ‘thin file’. ‘Thin file’ literally means that there is little data within your credit report for the lender to base their decision upon.
This creates an issue when you go to apply for credit as lenders, when reviewing your credit history, are unable to judge how reliable you’ll be in paying it back. Essentially without a track record, how you handle credit is an unknown. In the eyes of lenders this means that you’re higher risk. Consequently, you may find it challenging to get approved for credit, or if you are, that you are offered high interest rates on financial products reflecting this perceived risk.
Another important thing to consider is that when you submit an application to borrow money, and the lender checks your credit report, this leaves a mark. It’s referred to as a ‘hard check’ and too many of these in a short space of time is considered a bad thing by lenders, and so it causes your credit score to go down.
This is why it’s wise to look at your credit reports ahead of applying for credit to consider how likely you are to be approved. If your credit score suggests it’s unlikely, you might think about improving your chances first, then applying. Loqbox is the free and easy way to build your credit score while you save. Find out more here.
Checking your credit reports also gives you the opportunity to check that all the information on your credit reports is accurate and up to date. If not, be aware that incorrect information may damage your chances of getting approved for credit. So it’s best to take steps to correct any mistakes you find (here’s how).
There are three main credit references agencies in the UK — Experian, Equifax and TransUnion. And each holds a separate credit report on you. So it’s important to check all three.
It's free to check your credit reports online. Try it now using the following services:
- ClearScore (uses Equifax data)*
- Credit Club (uses Experian data)
- Credit Monitor (uses TransUnion data)
* Just to be super transparent if you sign up and follow this link although it's free for you, Loqbox may get a small referral fee from ClearScore. This helps us to continue to improve our service for our customers and keep Loqbox free.
2. Shop around to find the best deal for you
Use comparison sites like MoneySupermarket to get quotes and compare offers tailored to your needs. However, bear in mind that sometimes it can be cheaper to go to lenders directly.
Annual percentage rate (APR) represents the cost of borrowing money to you. Different products, and lenders, offer different APRs. So you want to find the deal with the lowest APR. Also note that people with good credit scores will generally be offered better deals. Find out more about APR in our video here:
If you’re buying a house, you may prefer to arrange your mortgage through a mortgage advisor. Mortgage advisors have a good understanding of the market and the financial products that are currently available, so they will be able to advise you on the best deals for you. They also help with making the application, and this can be particularly reassuring for first-time buyers. Mortgage advisors may be free or they may charge a fee of somewhere around the £500 mark.
3. Make the application
When you’ve chosen the product you want to apply for, it’s time to make the application. You can usually do this online via a form. Application processes can vary, but to fill in the application forms, you’ll likely need:
- Personal details such as your name and address
- Your ID (like a passport or driving license)
- Your bank details
- Your current address and address history covering the last three years
- Details about your incomings and outgoings (including debts)
- Information about your employment (including payslips)
- Your national insurance number
4. Make your repayments on time and in full
Once your application has been approved and your credit has been arranged, be sure to make your repayments on time and in full as per the terms of your agreement. Not doing so can severely harm your credit score amongst other things that your lender will have made you aware of.
How long does it take to arrange credit?
The time it takes to have your application processed and receive funds will vary. But here are some general timings below for how long it could take.
You may be notified instantly after submitting your application as to whether you have been successful. But it can take seven to 10 working days for your new card to come through the post.
Increase your chances of getting approved for credit
Improving your credit score helps to increase your likelihood of getting approved for credit — and being offered the best rates. Loqbox is the free and easy way to build your credit score while you save. Find out more and get started now. And for more tips on how to improve your credit score, check out our article here.