How does borrowing money work?
Curriculum for Life editorial team
Most people borrow money in some way – whether for big buys or smaller items. If you’re thinking about borrowing money, find out the basics first.
What is borrowing money?
Money that you have borrowed is called debt! This means you owe it to someone – often a bank or other financial company.
When you borrow money, you are usually charged interest. This is a charge for the cost of borrowing, on top of the amount you have borrowed.
The interest rate for borrowing money is usually shown as the APR (annual percentage rate) which reflects how much your debt would increase each year. The higher the APR, the more you pay. So if you borrow £100 at 20% APR, you would owe £120.
How much it costs you to pay back depends on a range of things, including how quickly you repay the money you owe. If you have a loan over a longer duration, you’ll pay more interest because the interest is added every month or year.
How do I borrow money?
There are different ways you can borrow money.
The most common ways are:
- Loan – where you borrow a fixed sum and pay it back in regular amounts.
- Credit – where you can borrow up to a certain amount which you can use in part or full.
With some debts, such as credit cards, if you repay the full amount owed each month you don’t pay any interest. But if you only make the minimum repayment you will be charged interest, so you can soon owe much more.
If you want to find out more about credit cards, watch the video to the right.
What can you afford to borrow?
Before considering what to borrow, think about how you will pay it back. When you borrow money, you usually pay back what you owe over a period of a time. For example, you may pay back a loan in monthly instalments over two years. Look at your budget to see how much can you afford to pay.
For more tips on managing your money and cutting costs, see What is a budget and do I need one?
For more on saving, see How can I pay for a car, holiday or other high-value item?
What types of borrowing are there?
- Mortgages
- Bank loans and credit cards
- Buy now pay later services
- Overdrafts
- Student loans
- Credit union loans
- Payday loans
- Money borrowed from someone personally
If you don’t want to borrow money for religious or other reasons, there may be alternatives. For example, you can get plans to help you buy a house which comply with Sharia law.
How much can I borrow?
The money you can borrow depends on your situation. This includes things like how much money you earn and what other debts you have. You may also need to a pay a deposit – an amount of money upfront towards the total cost of your purchase.
Lenders often look at your credit score to help decide how much to lend you.
Your credit score is based on information such as if you’ve missed repayments in the past and how many accounts you have. This is used to suggest how likely you are to pay your future bills on time.
See how to check your credit report to find out more.
What can do I do if I’m struggling to pay?
The best thing to do is speak to a debt advisor. A debt advisor can help you work out the best solution for you, as different options can affect you in different ways in the future.
You may be able to arrange an easier way to pay your debt back, such as making smaller payments over a longer period of time. Other options include applying for a Debt Relief Order or Bankruptcy.
These services can also help:
- Step Change – debt charity
- National Debtline – debt charity helpline
- Mental Health and Money Advice from Mental Health UK Charity
What happens if I don’t keep up with my repayments?
There are two different types of debts:
Priority debts:
If you don’t keep up with your repayments, you could end up losing your home, having your energy supply cut off, or items repossessed (taken away).
Non-priority debts:
With other debts, such as credit cards and bank overdrafts, you could face going to court and being ordered to pay.
Owing money to friends, family or other people
Things sometimes get difficult when you owe money to friends, family members or people you don’t know very well, especially if you can’t pay back what you owe.
You can contact the Samaritans free at any time, by phone or by email.
Samaritans responds to a call for help for anyone who’s struggling to cope, who needs someone to listen without judgement.
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