Different types of Borrowing Flashcards
Explain a Overdraft
This allows you to withdraw money that you do not have from a current account. It may be suitable to meet short term needs, for example a shortage of cash just before payday.
What are advantages and disadvantages of a Overdraft
Advantages:
Interest is charged only on the amount outstanding.
Can be paid off without penalties.
An overdraft facility can be prearranged and only used if needed.
Provides a short term solution to cash flow problems.
Disadvantages:
When used, interest charges are often high.
Additional penalty charges for going over a pre-arranged limit are often very high.
Not the cheapest form of borrowing.
The ease with which these can be obtained could encourage overspending.
Explain a Personal Loan
It gives you the ability to borrow a set amount of money, normally for a specific purpose, to be repaid in regular instalments with interest. It may be suitable to fund the purchase of a high price item such as a car or to make home improvements.
What are advantages and disadvantages of a Personal Loan
Advantages:
Regular, pre-agreed payments make planning and budgeting easy.
As a general rule these would only be issued to individuals who can prove their ability to make the repayments.
Useful when looking to purchase a specific item of medium to high value, e.g. a car or home improvement.
Disadvantages:
May have to be secured against an asset which means if payments are missed the asset may be taken to cover the outstanding debt.
Not really suitable for short term loans.
Explain a Hire Purchase
A Hire Purchase lets you have an item immediately but pay for it in regular instalments. The item is owned by the seller until all payments are made. It may be suitable for one-off or infrequent purchases, for example a TV or a fridge.
What are advantages and disadvantages of a Hire Purchase
Advantages:
Spreads the cost of an expensive item over a period of time.
Credit is secured agaisnt a specific item.
Often allows a customer to afford something now they could not otherwise afford.
Disadvantages:
Interest charges may be higher than other loan types.
Ownership of the asset may legally be kept by the seller until the final payment is made.
Agreements can be manipulated to make a purchase seem deceptively appealing.
Explain a Mortgage
This is a long-term loan to fund the purchase of assets, normally paid back over a long time, for example 25 years. It is suitable for assets that will maintain value for a long time and cannot be paid outright.
What are advantages and disadvantages of a Mortgage
Advantages:
Allows the customer to spread the cost of very expensive items over a long period of time.
Interest rates, depending on the mortgage deal, can sometimes be fixed or tracked against a standard rate of interest reducing the risk of fluctuations.
Disadvantages:
Interest payments, although sometimes fixed for a short period of time.
Failure to meet repayments may lead to a loss of home and seriously affect their credit rating.
Penalties may be applied to early repayment.
Explain a Credit Card
Goods are paid for by a card and can be paid for either at the end of a set period of normally a month. It may be suitable when buying high price goods or services, for example a holiday, or at times when expenses are higher than usual. It may also just be used for convenience and safety as an alternative to using cash.
What are advantages and disadvantages of a Credit Card
Advantages:
The credit card holder can pay above the minimum rate if they wish which reduces interest incurred costs.
Can be used for items of multiple size and value, to a limit, without the need to secure against an asset.
Provides some protection on purchases.
Disadvantages:
Can encourage overspending, sometimes on unnecessary purchases, and can lead to debt problems.
Interest rates are often higher than on a personal loan.
Explain a Payday Loan
This is a short term source of finance used to bridge the gap between now and next receiving a wage. It will normally only be available for relatively small amounts at very high rates. It may be suitable in an emergency to meet cash shortages.
What are advantages and disadvantages of a Payday Loan
Advantages:
Help solve immediate short term cash flow problems.
Easy to secure, making them an option for people with low credit ratings.
Disadvantages:
Interest rates are very high and the cumulative amount to be repaid can quickly spiral out of control.
