A guide to borrowing money

Borrowing money is a normality in the UK. In 2020 alone, over 80% of adults used some form of consumer credit throughout the year. Whether it was an overdraft, credit card or personal loan, borrowing money has become a feature of everyday life. 

Borrowing money isn’t just used to make ends meet or to cover unexcused expenses, but it’s also used for big purchases like home improvements, new cars or weddings. For a lot of people, when it comes to borrowing money, it can be a difficult, stressful and complicated time. 

There are so many ways to borrow, from banks and high street lenders to your friends and family who surround you. This guide will cover the different ways you can borrow money, what to watch out for and how to do it right👇

Disclaimer: This guide is intended to be used for informational purposes only and it does not constitute financial or legal advice. All content is believed to be accurate at the time of publishing. ‍‍

What we cover in this guide 🤘

Ways to borrow money?

Personal loans

Banks, high street lenders or credit unions can lend you money. Typically these are in the range of £1000 - £20,000. Personal loans require a formal application process to be approved. They are a good option for people with a good credit score, those with lower scores may struggle to be approved.

‍Payday loans

Payday loans are for people who need a quick source of cash. Payday loans are often used by people who have been rejected for a personal loan or need to be approved straight away. Interest rates can be as high as 292% per year. Payday loans make up a form of high-cost short-term (HCSC) credit and should be used a last resort.

Guarantor Loans

A guarantor loan is when borrowers are provided credit from a lender based on guarantor support - typically used where a borrower has a thin or poor credit history. If a borrower can’t repay and defaults, guarantors need to step in and make good on loan - with typical interest rates of 50% (APR).

These loans can be for large sums of money anywhere from £1000 up to £20,000. These loans put the guarantor at risk of paying back huge sums of money if a borrower defaults.

‍P2P Loans

Peer-to-peer lending (P2P) is a way for borrowers to get funding without going to the traditional sources of finance, such as banks and building societies. This is a way to borrow money from a pool of individual investors. 

The interest rates on peer-to-peer loans vary significantly depending on how much of a risk you’re seen as being. You could secure loans from 3% with a great credit score, but may be looking upwards of 30% if you have a bad credit history. ‍

Why you may struggle to borrow money

‍To be legally binding, yes, the loan agreement will not hold up in court if it's agreed verbally or with a handshake. It should be written and signed by the lender and borrower. This provides clarity to both the parties involved and displays the terms and conditions of the agreement. Lots of people find it hard to even access or are even excluded from affordable credit. 

This is because traditional borrowing is backed by Credit scoring, a system used by financial lenders to decide how much risk it is to lend to you. Credit scores are built on historic credit data and generally the higher it is, the less of a credit risk you are. If your score is below a certain number, you could be turned down for a loan or charged more for the service. 

This system works for those with high credit scores; they're seen as less risk and pay lower rates back to the creditor. However, this demographic is usually older, has had an established credit history for several years, they have a mortgage, credit cards or some other form of credit product.

Young people, those new to the country or those who haven’t used credit before will; likely find it difficult to access loans at affordable rates or be accepted at all. ‍

Difference between APR & Interest?  

Interest tells you the percentage of your loan that is added on over a set period of time. Interest rates can be calculated across any period. From a daily basis to the more common way being monthly or annually. 

For example, if you borrow £1000 at a 10% interest rate over a month, you’ll be due to pay back £1100.

The interest here equals £100. 

If you borrow £1000 at a 10% across a year, the same interest will be applied and you’ll be due to repay £1100.

‍Compound interest

If the interest compounds, this means the following interest will be applied to the total amount. 

Using the same example as above, if in Year one who have to repay £1100 in total.

If this was a 2 year loan, you would be due to repay £1111 in the second year (the extra £11 is a result of 10% of the £100 interest that’s already been generated)

So for a 2 year loan of £1000 at 10% interest, the total would equate to £221. 

‍What’s different about APR?

‍APR includes any extra fees or charges included. For example, this could be a fee for new users.

The representative APR that you see tied to personal finance products is the offer given to at least 51% of customers (the majority). These won’t always be the rates applied to you.

 Representative APR will always take compound interest into account to reflect the real cost to you. 

Benefits of f&f loans  

Affordability

‍With the average cost of credit card interest around 20%, overdrafts nearer 40%, and short-term loans much higher than this, borrowing money from friends and family can often be a much more affordable route of finance with lower interest rates or none at all.  

‍Ease

There are no forms to fill in or long credit check processes, which leads to a faster route to accessing the finance you need. It also allows people with bad or limited credit history to attain affordable rates. 

‍Flexibility

Traditional loans and credit products have strict payback terms, whereas you can negotiate more flexible terms with people you know.  

‍Understanding

‍Friends and family are more likely to be understanding if there are difficulties making repayments, whereas commercial lenders may threaten legal action if payments fall behind schedule.‍

Risks?  

As with all forms of investing and borrowing, loan agreements between friends and family come with risks.

 Not getting paid back

This is one of the top concerns lenders have. Missing payments or not living up to your end of the agreement can strain your relationship with the person you’re borrowing or lending to. 

‍The strain on relationships

‍While this is especially the case if payments are missed, even without breaking the agreement, just the act of loaning someone money can subtly change your relationship dynamic. It’s something both the lender and the borrower should check in to make sure they’re comfortable with it. If not, it doesn’t need to end the discussion. There are ways to reintroduce more balance by, for example, agreeing to pay back the loan with interest decided by both parties. More on this later.  

‍Finance may be limited, and the lender might need the cash.

‍What happens if the lender suddenly faces unexpected financial circumstances during the loan term?  Could this lead to a dispute or them asking for the loaned money back? People you know simply may not have the amount of cash that covers what you need.  

‍Awkwardness. Lots of people find broaching the subject of borrowing money awkward. It’s understandable. But it doesn’t have to be.‍

 How to borrow money from friends & family

We’ve talked about the benefits of borrowing from the people know, and the risks to look out for. Going about friendly loans in the right way will mitigate.  

First. Go through this checklist. If you’d struggle to tick any of these boxes, perhaps it isn’t the best time to be borrowing money from friends or family.  

- Is my friend & family member in a position to lend me money right now? (do they have steady income etc)

- Do I feel confident that I will be able to repay the loan?

- Do you have a budget in place?

- Is the person I am borrowing from someone who I can be open and honest with?

- Am I ready to be completely transparent about my financial situation?

- When you can answer these questions here’s how you should plan to go about asking your friend or family member.  

‍Step 1: Broach the subject

Pick a time, be open, honest This is likely the most difficult part of the whole process so take strength in knowing that this part requires the most courage. Arrange a time with your friend or family member you would like to approach for a short-term loan. Be humble, be genuine and don’t be afraid to be completely honest about the impact that your financial situation is having on your life.   

‍Step 2: Be prepared

‍Bring along some notes or prepare a spreadsheet showing your friend or family member what you need the loan form, how much you need to borrow and how you plan to repay it. This will increase the confidence the lender will have in you sticking to your word and making good on the loan.  

‍Step 3: Make a solid agreement

By creating a written loan agreement both parties will understand exactly what is expected of them. This formalises the loans and displays you’re willing to make the agreement legally binding.   

‍Step 4: Live up to your end of the terms

The last step is about sticking to your word and following the plan that you made. Treat this loan just as you would if you borrowed it from a bank. If at any point you have concerns around an upcoming payment, have an open conversation with your friend or family member.

Dangers to watch out for when borrowing from friends or family 

Loan Sharks 

A money lender has to be authorised by the FCA to lend money legally, just like banks and other mainstream ways of lending. Money lenders who the FCA doesn’t authorise are breaking the law. They are known as loan sharks. 

Not all lending must be authorised by the FCA. Informal loans between friends and family aren’t against the law. 

Loan sharks often charge very high-interest rates, do not operate with paperwork, and carry out illegal acts to collect their money. Like harassing you on the street or threatening you with violence.All authorised money lenders must be registered on the FCA website.

If you’re unsure or want to check the legitimacy of a potential loan shark or any money lender you’ve found online, this should be the first place to look: www.fca.org.uk

The chances are if you cannot find the person or persons on the register. They are not authorised to lend you money. 

What to do if you owe money to a loan shark?

In England, if you think a money lender is operating without being FCA authorised, you can speak in confidence to the Illegal Money Lending Hotline on 0300 555 2222.

You can also email the Illegal Money Lending Team at reportaloanshark@stoploansharks.gov.uk or text loan shark and your message to 60003.For more information, check out: https://www.citizensadvice.org.uk/debt-and-money/borrowing-money/types-of-borrowing/loans/loan-shark

Wrapping up

We hope this guide clears up some of the misinformation around borrowing money and shows you how to borrow money from the people you know.