The Ultimate Personal Loan Guide Chapter Four - Personal Loans, Overdrafts And Credit Cards

Are you confused by the loan options available? Personal Loans Now (FCA regulated) provides a detailed review of personal loans, credit cards and the use of overdrafts. What are the advantages of each one and what are the drawbacks? Read on to find out more.

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Learning Highlights
  • Learn about different types of borrowing,
  • Unsecured personal loan or an overdraft,
  • Agreed overdrafts,
  • How interest is calculated and charged,
  • Borrowing cash on credit cards,
  • CC rates of interest and charges,
  • 0% credit cards or personal loans

What are the Best Loan Options?

When times are hard and money is tight, many people need to borrow money to pay for a large purchase such as a new central heating boiler or a new car to take them to work. Some of these purchases are essential. Unless you have savings put to one side, you may need to borrow from one source or another. So, what is the best way to finance large purchases like these? What are the best loan options?

In the past, loan options were limited to the local bank. In the 21st century, modern financial institutions mean that there are many options for both long and short term borrowing. If you only need the money for a very short space of time, you could consider using the overdraft facility from your bank (if you have one). Alternatively, there are also payday unsecured personal loans which can prove helpful as a short term solution. These can also be very expensive.

In this article, Personal Loans Now compares the different loan options. We will specifically look at a personal loan, using a credit card and using an overdraft.

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Understanding the benefits and drawbacks of each of these three methods of borrowing will help you work out which is the best and cheapest option for your current financial circumstances.

Is A Personal Loan Better Than An Overdraft?

Most major banks will grant an overdraft arrangement if you have a current account. This is provided that you have wage and have shown responsibility in running the account. It could be as part of the terms of the account or if you make a specific request for such a facility.

Some banks allow a ‘no fee’ overdraft for a limited amount. It may be between £250 and £500. A free overdraft facility means you will not pay interest on the small amount of borrowing. The overdraft can run every month. You will not be able to use a higher amount without paying monthly interest and possibly a fee.

Using a free overdraft can be very useful if you are sure you can pay the money back relatively quickly. For example; from savings or your next month’s salary. A small free overdraft will not be any use if you want to buy a new car.

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It could help if you need instant access to money to pay for a central heating repair, a leaking roof repair or to fix a broken down vehicle.

The Agreed Overdraft Facility On A Bank Account

Access to an agreed overdraft facility is a useful method of borrowing money for a short period such as an emergency.

When you have access to a free overdraft limit but need more funds, you can agree an authorised overdraft with your bank. This will have a set upper limit. Using an authorised overdraft will require you to pay interest. Details of this will be in the terms and conditions of your bank account. Some banks also charge a monthly fee for providing an overdraft. Banks offer different rates and different terms for overdrafts. Check the terms and conditions of your account.

Using an Arranged Overdraft

If you use the agreed overdraft but exceed the limit set, you will be immediately charged a fee. In the past, this would be as much as £40 for one transgression. After a study in 2008 and a subsequent court case in 2009 (which the banks won), the Office of Fair Trading was instrumental in forcing banks to reduce this fee to around £10.

Loan options - personal loans now

Unfortunately, although the banks surrendered on this aspect of charging for unauthorised overdrafts, the result was higher interest charges for authorised overdrafts. Also, many banks do not allow customers to opt out of unauthorised overdrafts.

There is also a restriction on charges a bank can make in anyone month if a customer goes over the agreed limit. Banks are allowed to set their own limits on what to charge in a month.

Examples of Bank Charges on Overdrafts:
Bank Account Unarranged Overdraft Fee Fee Capped at:
Santander 123 Current Account £6 per day £95 per month
Lloyds Club Account Between £10 and £25 £5 fee per day. Above £25 the charge is £10 per day. £80 per month plus interest
RBS/Natwest Select Account £6 per day £90 per month

As long as your credit history is good and you have not exceeded the authorised overdraft limit you can switch banks to get a better deal

Overdraft Buffer Zones

Banks have now agreed to a ‘buffer zone’. It means they will not make charges on overdraft limits exceeded by a small amount. The buffer zone is a voluntary feature and varies with each bank. It might be as low as £6 or up to around £15.

Continually using an overdraft facility to the maximum amount can affect your ability to borrow in the future. Also, the bank has the right to summarily terminate the agreed overdraft amount. They can also demand immediate repayment of all the money you have borrowed. It could cause real problems when you have already spent the funds.

How Is Interest Calculated On An Overdraft?

Typically, interest is calculated on the end of day debit balance on a bank account. Most banks will deduct this from your account each month. The bank must notify you of the amount of interest before they deduct it.

Interest rates for overdrafts vary enormously with First Direct charging 15.9% as the Effective Annual Rate while Lloyds charges 19.89% EAR. Some banks charge different rates depending on which type of account you hold.

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Of course, these rates look very high compared to personal loans rates. However, an overdraft is only designed to use for short term borrowing. An example would be if you used an overdraft of £500 for 30 days, the interest would come to £6.10 if you are a First Direct customer and would amount to £7.51 if you use Lloyds.

Before using an overdraft, it is important to check what the current rate of interest is for your bank. It becomes clear that if you need only a small amount for a short time, then an overdraft is a useful option instead of a personal loan which will run for a longer period and cost you more in interest.

Personal Loan Versus Overdraft

If you want to borrow a substantial amount of money for a large purchase, then a personal loan offers better options than an overdraft. You will not be put under pressure to pay it off early. You will be fully aware of the total cost of the loan and how much you must pay each month. This helps to facilitate a monthly household budget.

Loan options - personal loans now

In addition, as long as you keep strictly to the terms of the agreement then the finance company or bank cannot demand the immediate repayment of the loan in full.

There is also the matter of the rate of interest. Overdrafts rates may go up (or down) following bank base rate changes. But, a fixed-rate personal loan will remain the same until the end of the term.

Compare Credit Cards and Personal Loans?

Most financial advisors will agree that borrowing money from a credit card is not recommended. Not only do you pay a high rate of interest but you also get charged a fee for withdrawing cash.

A typical interest rate on a credit card is around 18.9% APR. Borrowing £500 for 30 days from a card at this rate would attract interest charges of £7.17. However, there could also be a set fee for withdrawing cash and many banks charge a higher interest rate for using this service. This might be as much as 6% more than the normal interest rate charged for transactions in shops.

Loan options - personal loans now

Furthermore, the temptation to pay only the minimum amount due at the end of the month makes this even more expensive. Interest charges quickly rack up and result in higher costs as you are paying interest on interest.

For the above reasons a financial expert will always suggest that credit cards only be used for purchases and not for cash. For the sake of your financial well-being, you should always try to clear the balance of your credit card at the end of the month.

Hidden Charges On Credit Cards

It is not always apparent when using a credit card that the accruing interest for cash withdrawals begins at the date the withdrawal is made and not at the end of month statement date. Additionally, you can easily fall foul of charges for late payments if your statement arrives late. Thus attracting, even more, fees and interest.

If you do use a credit card regularly, then Internet banking is highly recommended. Using this can keep up to date with statements and the total amount you owe.

What About 0% Interest Credit Cards?

Loan options - personal loans now

Using a credit card that offers a 0% interest rate instead of a personal loan may look like a good idea. In some instances, it can be. However, you need to be strictly disciplined about clearing the balance before the 0% interest period runs out.

Most credit card companies will charge much higher than average interest rates when the 0% period has expired.

Credit Card Or Personal Loan Options?

Lowest personal loan rates are better than a credit card (even a 0% interest card) for peace of mind. You know exactly how much you are charged in interest and how much the repayments are each month.
However, if you can be sure that you will pay off all the money owed before the 0% deal runs out then a credit card could prove to be a good way of borrowing money without paying interest. Only you can decide which option will suit your current lifestyle and financial circumstances.

Summary: Loan Options Available

Personal Loans Now discussed the loan options. We showed the different methods of borrowing cash using personal loans, overdrafts and credit cards. This included the costs of borrowing loan options and learning about terms of the accounts, extra fees and interest rates.

Loan Options - Personal loans now