Topic 5 Flashcards
Q: What is borrowing used for in relation to income and expenditure?
A: Borrowing helps smooth out differences in timing between income and expenditure, such as when someone is short of funds at the end of the month
Q: What is a deficit in terms of personal finance?
A: A deficit occurs when spending exceeds monthly income, resulting in a negative bank balance
Q: Why might borrowing to cover a temporary deficit be sensible?
A: It is sensible if you know you will have extra money next month to repay it
Q: What risk is associated with borrowing to cover ongoing deficits?
A: The risk of accumulating rising debt that you may not be able to repay
Q: Name three common items people borrow money to buy.
A: A house, a car, and furniture
Q: What is a mortgage loan?
A: A loan taken out to buy a house, typically repaid over many years
Why do mortgage loans have lower interest rates compared to other loans?
A: Because the loan is secured against the property, reducing the lender’s risk.
Q: What happens if a borrower cannot maintain mortgage repayments?
A: The lender can sell the property to recover losses.
Q: What is ‘equity’ in the context of homeownership?
A: The difference between the amount owed on a mortgage and the market value of the house
Q: How can positive equity be used?
A: As security for loans to finance purchases, home improvements, life events, or emergencies
Q: Why would buying a home be impossible for most people without a mortgage?
A: Because it allows them to spread repayments over 25 years or more
Q: What happens to future income when someone borrows money?
A: Borrowers must repay the debt from future income, reducing the amount available for other spending
What is the opportunity cost of borrowing?
A: The value of the best alternative purchase that could have been made with the money used to repay the loan
What is the cost of borrowing called?
A: Interest
Why do lenders charge interest?
A: To compensate for the use of their money and the risk that the borrower might default
Q: Which type of loan typically has the lowest interest rates and why?
A: Mortgages, because they are secured on the property.
Q: Name a type of debt that is very expensive.
A: Payday loans.
Q: What is a major risk borrowers face when repaying debt from future income?
A: They may lose their job or face unexpected expenses, affecting their ability to repay
What is hardcore debt?
A: Debt that the borrower will never be able to repay, often leading to serious financial and psychological stress
What happens if a borrower defaults on a secured loan, such as a mortgage?
A: They will lose the asset, such as their home
What is the consequence of defaulting on a hire purchase agreement?
A: The borrower will lose the goods and cannot recover the payments already made
What is a financial footprint, and why is it important?
refers to a person’s credit reputation. A bad financial footprint can make it difficult to get credit in the future
Q: What is the worst-case scenario for someone who cannot repay their debts?
A: They could be declared bankrupt
Q: How can borrowing lead to psychological effects?
A: Debt stress can affect the borrower and their relatives and friends, causing anxiety and worry.
Defaulting on a loan is a serious matter:
If the loan is secured on an asset, such as a mortgage secured on a home, the borrowers will lose that asset - their home - if they stop meeting the repayments. If the borrowing is in the form of a hire purchase agreement, the borrower will lose the goods and will not be able to recoup the payments already made.
If the loan is unsecured, the defaulter will obtain a bad financial reputation or ‘financial footprint ‘, which means that they may be unable to get credit again. In the worst case, the person could be declared bankrupt.
Why are young people more likely to borrow compared to older people
A: Young people often need loans to finance their studies, cover day-to-day expenses, and manage larger expenditures
What contributed to the 2007-08 financial crisis in terms of borrowing and lending behavior?
A: Irresponsible lending practices, such as providing credit to those unable to repay, contributed to the crisis
Q: How did the financial crisis impact people’s employment and borrowing?
A: Many people lost their jobs, making it harder to repay debts, which worsened the impact of unemployment for those who already owed money
Q: What happened to mortgage repossessions after 2007?
increased significantly, with 46,000 homes repossessed in 2009, the highest since 1995
Q: What trend was observed in mortgage arrears from 2009 to 2017?
peaked in 2009 at 196,000 cases but gradually declined to 88,300 by 2017
What is “loan forbearance”?
A: It is a temporary allowance given to borrowers experiencing financial difficulty, allowing them to pause or reduce repayments.
Q: What might happen to repossessions if interest rates rise?
A: Repossessions are likely to increase, as people may struggle to meet higher repayments
Q: How has societal perception of debt changed over time?
A: Debt, once considered undesirable, is now viewed as a normal part of life for both individuals and businesses.
Q: What long-term effect did the financial crisis have on attitudes towards borrowing?
A: People became more cautious about borrowing in the immediate aftermath, although this effect may be short-lived
Q: How have lenders changed their behavior post-financial crisis?
A: Lenders have become more selective, approving loans for customers with better credit histories and increasing interest rates on lending products
Q: Why did credit card rates rise between 2006 and 2011?
A: Rates rose due to the high risk of default and the need for providers to compensate for large amounts of debt write-offs after the crisis.
Balancing benefits and costs
When looking to borrow individuals should:
- Consider their current debt situation and assess whether it would be a good idea to borrow more
- Compare different products to find the best deal (but don’t apply for lots of different products as this could have a negative affect on the individual’s credit file)
- Ensure the interest rate they pay is reasonable when considered against the purpose of the loan
- Consider the appropriate length of time a loan should be for, I.e 25 year mortgage would be appropriate for a house purchase
Q: What should someone consider when financing expenditure with a loan?
A: Both the benefits and costs of borrowing
Q: Why should the advantages and disadvantages of loans not be considered in isolation?
A: Because they should be assessed in light of other loans the borrower might already have taken out, considering the overall debt situation.
Q: How should the length of a loan correspond to the life of the item purchased?
A: A longer loan is suitable for long-term assets like a house but not for short-term items like a computer
Q: What influences an individual’s decision to borrow?
A: Their attitude to debt and risk, as well as the cultural and ethical values of the group they belong to
Q: To what extent do people borrow money?
A: Only to the extent with which they feel comfortable.
Q: How should borrowing decisions fit into an individual’s financial plan?
A: Borrowing decisions should be integrated into short-term and medium-term budgeting plans, cash-flow forecasts, and justified as part of a long-term financial plan
Q: What are the three major credit reference agencies in the UK?
A:
1. Experian: www.experian.co.uk
2. Equifax: www.equifax.co.uk
3. TransUnion: www.transunion.co.uk
What information do credit reference agencies use to compile consumer profiles?
A:
• Data from banks, building societies, and credit card companies.
• Information from county court judgments (CCJs), the electoral register, bankruptcy orders, and house repossessions
What details about loans and repayments are recorded by credit reference agencies?
A:
• Details of every loan, credit card, or credit agreement an individual has.
• The amount borrowed and payment history, including adherence to monthly payments.
Do credit reference agencies decide on loan approvals?
A:
No, they only provide information to lenders. They do not make decisions or keep a “blacklist.
What happens when a person applies for a borrowing product?
A:
• The lender searches the applicant’s credit file, leaving an electronic “footprint.”
• Multiple searches may indicate financial difficulties to lenders
What causes negative financial footprints on a credit history?
A:
• Missing payments or payment arrears.
• Defaulting on loan agreements.
• Missing payments on mobile phone contracts
Why might a financial institution refuse credit to an applicant?
A:
• If the applicant has borrowed too much.
• If they have a poor repayment history
