Borrowing money

We live in a world today where it is difficult to get by without borrowing money at least some of the time.

Step 1: Why people borrow

If we did not borrow, most of us would never be able to afford to buy expensive things like a home or a car and would find it difficult to cover the cost of lots of big items, such as furniture and electrical goods. By borrowing, we can have whatever it is we need or want to buy now but spread the cost of it over time. Borrowed money also plays a big part in helping us achieve goals and move forward with our lives. For example, we may borrow money to pay for our education or to help us set up a business. Borrowing can also help tide us over.

We often hear borrowing talked about as if it is a bad thing, but, as long as we know why we’re borrowing and how we’re going to pay it back, it can be useful.

Step 2: How borrowing works

When we borrow money, the chances are that the person or company that is lending to us will want something in return. Most of the time, this ‘something’ is interest, which is an extra sum of money that we pay back on top of the money we originally borrowed. See Interest
Secured loans: Some of the time when we borrow money, whoever it is that has lent us the money wants more than just our word that we will pay it back. Before they lend us the money, we agree that if we cannot pay it back, they can have something of ours that they can then sell to get their money back. This is called secured lending and an example of a secured loan is a mortgage: if we fail to pay back the money, our mortgage lender can take our home away from us and sell it to get the money back.

Step 3: Different types of borrowing

There are lots of different ways to borrow money:

Loans – if we take out a loan, we are usually borrowing a set amount of money over a certain time
Mortgages – these are loans that we use to buy homes. Because we borrow so much money, they can take about 25 years to pay back
Overdrafts – an overdraft is a sort of loan facility that banks can let us have on our current account. They let us take out more money than we have in our account
Credit - is the word we use to describe getting something now and paying for it later. There are lots of different sorts of credit, for example:
Credit cards, which are plastic cards that we can use to pay for things instead of cash. The Money Made Clear website has more information about how credit cards work (link opens in a new window)
Hire purchase. In this case, when we buy something, we usually pay some of the money upfront and the rest in instalments over a certain period of time.

Step 4: Where we borrow from

As well as different ways to borrow money, there are also lots of different places to borrow money from:

Banks and building societies provide loans, mortgages, overdrafts and credit cards
Other financial companies offer us loans, mortgages and specialised facilities for things like buying cars
Credit unions offer loans to their members
The Student Loans Company, which is owned by the government, lends money to students to help them pay for higher education
The Social Fund provides Budgeting loans to people on various benefits as well as Crisis loans
The alternative credit market, which is made up of things like pawnbrokers, door-to-door moneylenders and cheque cashers
Family and friends.

Step 5: The pitfalls of borrowing

Because of interest, when we borrow money to pay for things, they usually end up costing us more than they would if we had paid cash
If we struggle to pay back the money we borrowed or do not pay it back in the agreed period, the amount we owe keeps growing. See Interest
If we cannot pay back the money we borrowed, we could end up losing our possessions or our home. See Managing debt
Sometimes you can even get penalised for paying back money early so when you borrow, it’s important to check if there are charges for early repayment.

Step 6: Would you like to know more?

The Money Made Clear website has a section on borrowing money (link opens in a new window) with lots of information on the different sorts of borrowing
The Money Made Clear website also has a Loan Calculator (link opens in a new window) that will help you to work out what your monthly repayments might be for various loan amounts, repayment periods and annual interest rates
The Consumer Direct website has information about choosing between using credit and cash (link opens in a new window), Credit and store cards (link opens in a new window), and key questions to ask before borrowing (link opens in a new window).

Last updated: 27 April 2010