Unit 3 Topic 5 Flashcards
When do people tend to borrow?
Everyone has different ways of thinking about and managing their money – and, more specifically, very different attitudes towards borrowing and debt. In general, people borrow when they have a cash deficit, or when they want to finance the purchase of goods and services that they cannot afford at present.
What does borrowing mean?
How do you describe someone that borrows?
Borrowing means drawing from future income flows to finance an item of expenditure now. Someone who has borrowed money is in debt to the lender; this is a legal relationship and arrangements must be made to pay back the debt plus interest.
What does someone’s total debt include?
A person’s total debt includes all of the money that they owe under different borrowing products and also borrowing from informal sources, such as from family and friends. Each separate borrowing decision adds to total debt.
How can borrowing help people?
Borrowing can help people to smooth out differences in timing between their income and expenditure. Someone who is always short of funds at the end of the month can use their credit card or overdraft to finance their purchases until the next salary payment arrives in their bank account.
How does borrowing have both benefits and costs (advantages and disadvantages)?
Borrowing money is a tool that some people use to their advantage, while others find themselves getting into financial difficulties when they cannot afford to maintain the repayments. Borrowing therefore has both benefits and costs.
What is a negative bank account balance called?
A negative balance at the end of the month – the result of spending more than your monthly income – is a deficit.
When is borrowing to cover a deficit good?
When is borrowing to cover a deficit bad?
Borrowing money to cover a deficit is sensible if you know that you will have extra money next month to repay it. But if you have to carry the deficit over to the following month and add to it to cover that month’s deficit, you will be in danger of accumulating a rising debt – money that you have borrowed, but which you cannot afford to pay back.
Why do most people borrow money?
Most people borrow money as a means of affording a substantial purchase, such as a house, a car or furniture, which they need to buy now, but which is too expensive to be funded only by current income. It might take someone too long to save up for an item that they need immediately or very soon; if they buy the item now with borrowed money, they can use it while they repay the loan.
What is the most common example of borrowing?
The most common example of borrowing is the mortgage loan: very few people are able to buy a house without taking out a mortgage loan, which they pay back while they are living in the house.
Why are interest rates lower for a mortgage loan than for other loans?
Interest rates are lower for a mortgage than for other loans because it is secured on the property. This means that there is less risk for the lender, as it can sell the property to recover its losses in the event that the borrower defaults on the loan (ie cannot afford to maintain their repayments).
What is defaulting on a loan?
Defaulting on a loan = cannot afford to maintain their repayments.
What does the long term factor of mortgage loans do to the monthly repayment size?
The long term of such a loan (mortgage loan) also means that monthly repayments are similar to – or sometimes less than – the rent that the borrower would otherwise have to pay for an equivalent property.
What happens when the mortgage of a house has been fully paid off?
Eventually, the house will belong to the borrower (when they have paid back all of the mortgage) and, if house prices have risen, they will make a capital gain (although they also risk losing money if house prices fall).
What is equity?
What can positive equity be used for?
The difference between the amount owed on the mortgage and the market value of the house is called ‘equity’;
If this is positive, it can be used as security for loans to finance other purchases, such as home improve -ments, or to finance a life event or emergency. More -over, people who own their homes may have a psycho -logical benefit, because they feel a sense of security and perhaps even pride, as long as they can still afford the repayments.
When someone borrows money, what are they agreeing to?
When someone borrows money, they agree to repay the debt from their future income. This means that they will have less left over from their future earnings until they have repaid their loans and so there is an opportunity cost, ie the value of the best alternative purchase that they could have made with this money.
What is the cost of borrowing?
Borrowing is a product that must be paid for; the cost is called ‘interest’. A borrower repays not only what was borrowed, but also a percentage interest charge on top of this to recompense the lender for the use of its money over the time of the loan and for the risk that it takes (that the borrower will default).
What type of debt is the most expensive?
What type of debt is the least expensive?
Some types of debt (such as payday loans) are very expensive, while others (such as personal loans) are much cheaper – and mortgages offer the lowest rates because they are secured on the property.
What is the representative APR for Payday loans?
Payday loan APR
Lending Stream 1,333% MoneyBoat 939.5%
What is the representative APR for Store cards?
Store cards APR
Argos 29.9% New Look 28.9%
What is the representative APR for credit cards that require good credit rating?
Credit cards (require good credit rating) Sainsbury’s Nectar Credit Card 20.9% Tesco Bank Low APR Card 9.9% Royal Bank of Scotland Credit Card 9.9%
What is the representative APR for credit cards that require poor credit rating?
Credit cards (poor credit rating) APR Metro Bank Personal Credit Card 14.9% Capital One Classic 34.9% Vanquis Visa Classic 39.9%
What is the representative APR for personal loans?
Personal loans (£7,500 unsecured – repaid over 36 to 60 months) Barclays Bank Personal Loan 5.5% Nationwide BS Personal Loan 2.9% M&S Bank Cardholder Loan 2.9%
What is the representative APR for mortgages?
Mortgages APR
Coventry 4.0% HSBC 3.5% First Direct 3.2%
Why does debt become a big problem for some people?
How does this debt accumulate?
Since people repay debts from future incomes, there is a chance that something might happen that affects their ability to repay, eg they may lose their job or be faced with a large unexpected expenditure. Debt can become a big problem for some people simply because they allow it to get out of control. Some people borrow more than they can afford to repay so that they can finance the purchase of goods and services that seem very attractive (and which are heavily marketed). They may find themselves taking out new loans to help them to repay old ones. Such a situation leads to what is known as ‘hardcore debt’.
What is hardcore debt?
What are its effects?
Hardcore debt – an amount of money that the borrower will never be able to pay off.
This type of debt can be very stressful, and the worry that it causes can have serious psychological effects not only on the borrower, but also on relatives and friends
What is the impact of defaulting on a loan that is secured?
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 borrower 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.
What is the impact of defaulting on an unsecured loan?
Defaulting on a loan is a serious matter.
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.
What is the majority view on borrowing?
What does this mean for providers?
Many people see borrowing as a normal thing to do and financial institutions compete for the opportunity to lend to people. Customers can shop around and get the best deal to suit their needs.
What group of the life cycle are more likely to have to borrow?
Young people are more likely to have to borrow when they are starting out in adult life than older people who have been working for some years. Younger people will need loans to finance their studies, day-to-day cash flow and the larger items of expenditure.
What has lead to increasing debt in recent years?
What did this lead to?
What event made debt even worse?
In recent years, there have been a lot of reports in the media about people who have not used their borrowing facilities wisely and now have too much debt. Providers have also been guilty of irresponsible lending – of providing credit too easily and lending money to people who could not afford to pay it back. This was one of the factors that led to the 2007–08 financial crisis, and to several banks and other institutions in a number of countries ceasing to trade or needing government help to survive. This financial crisis was followed by a recession, during which many people lost their jobs – and the impact of becoming unemployed and losing your income is even worse if you already owe money.
What has happened to mortgage repossessions and arrears after 2007?
Give some statistics to back this up.
The numbers of house repossessions and of mortgage arrears increased considerably after 2007, according to the Council of Mortgage Lenders (CML).
- Some 46,000 homes were repossessed in 2009 – the highest number since 1995. During the third quarter of 2017, however, only 1,300 mortgaged properties were repossessed, which was the lowest repossession rate on record
- The number of mortgages in arrears also hit a ten-year high of 196,000 in 2009, before falling to 169,600 in 2010. The level remained consistently high after the crisis – at 161,400 in 2011, 157,900 in 2012, 149,400 in 2013 and 125,100 in 2014. But by the third quarter of 2017, the number of arrears of 2.5 per cent or more fell to 88,300
- In 2020, arrears levels were at near-historic lows as banks, the government and the FCA supported borrowers through the emerging economic effects of Covid-19.
In November 2014 what did the CML report?
In terms of mortgage arrears and repossessions
In November 2014, the CML reported that:
Low interest rates, supported by intelligent communication and forbearance (ie tolerance), mean that mortgage arrears and repossessions continue to decline.
Why have mortgage repossessions fallen?
Mortgage repossessions have fallen partly because interest rates have remained relatively low and people are still managing to meet their monthly repayments, and partly because banks are showing more tolerance (known as ‘loan forbearance’) towards people who are experiencing temporary difficulties such as allowing them a period of grace or a repayment holiday (ie a period during which they make no, or lower, repayments). However, if interest rates rise, the situation will worsen and repossessions will increase.
What is a repayment holiday when talking about borrowing?
A repayment holiday = a period during which people make no, or lower, repayments.
What is a repayment holiday when talking about borrowing?
A repayment holiday = a period during which people make no, or lower, repayments.
What is a repayment holiday when talking about borrowing?
A repayment holiday = a period during which people make no, or lower, repayments.
What is a repayment holiday when talking about borrowing?
A repayment holiday = a period during which people make no, or lower, repayments.
What are the attitudes towards debt now?
What were the attitudes towards debt in the early to mid twentieth century?
Debt is commonplace in most modern Western societies for both businesses and individuals. In the early to mid twentieth century, any level of personal debt was generally considered to be bad; businesses, of course, still had to borrow to buy stock, to obtain premises and to allow them to trade. Nowadays, reasonable levels of personal debt are accepted as the norm. What the long-term impact of widespread criticisms of financial services in the wake of the financial crisis will be on people’s attitudes towards debt remains to be seen: in the immediate aftermath, they have become more wary of borrowing – but this effect may be relatively short-lived
How are lenders being more cautious when agreeing loans?
It is, however, certainly the case that lenders are being more cautious when agreeing mortgages and other loans: they are accepting only customers who have a better credit history and who are more likely to be able to repay. They have also increased the interest rates that they charge on some lending products. The average rates charged on credit cards, for example, rose steadily between 2006 and 2011, and in November 2020 the average rate was still 20.91 per cent. This was 20.9 per cent above the Bank rate, the reason being that credit card providers have been forced to write off large amounts of debt in the aftermath of the crisis. This ongoing high risk of default results in increased interest rates on unpaid balances.
What should be considered when applying to borrow money?
Someone who is considering financing expenditure with a loan should take both the benefits and costs of borrowing into account:
- The advantages and disadvantages of each individual loan should be considered not only independently, but also in light of any other loans that the prospective borrower might already have taken out. Prospective borrowers should look at their overall debt situation and not only at each loan separately.
- The price that the customer pays for a loan must be reasonable when compared with the purpose of the loan: are the items purchased worth the amount of interest being paid and could the money have been borrowed more cheaply elsewhere?
- The length of the loan should also correspond to the life of the article purchased. For example, the borrower will sensibly apply for a 25-year loan to fund the purchase of a new home – but not to finance the purchase of a computer.
What factors determine whether someone decides to borrow or not?
Whether or not an individual decides to borrow also naturally depends on their attitude to debt and to risk – and remember that the cultural group(s) to which they belong and their ethical values are likely to have shaped these attitudes. People borrow only to the extent with which they feel comfortable.
How can borrowing decisions be dealt with to ensure sustainable personal finances?
To maintain sustainable personal finances, an individual’s borrowing decisions should not be taken in isolation, but should be both integrated into their short-term and medium-term budgeting plans and cash-flow forecasts and fully justified as part of their long-term financial plan.
How can borrowing decisions be dealt with to ensure sustainable personal finances?
To maintain sustainable personal finances, an individual’s borrowing decisions should not be taken in isolation, but should be both integrated into their short-term and medium-term budgeting plans and cash-flow forecasts and fully justified as part of their long-term financial plan.
What does a lender look into when someone wants to buy a borrowing product?
What companies offer this service?
When a potential borrower approaches a bank or finance company for a loan, the lender researches their credit history. There are three large credit reference agencies in the UK:
- Experian, online at www.experian.co.uk;
- Equifax, online at www.equifax.co.uk;
- TransUnion, online at www.transunion.co.uk
How do credit reference agencies check someone’s credit rating?
These companies (credit reference companies) compile files on consumers using information from banks, building societies and credit card companies, and also from county court judgments (CCJs), the electoral register, bankruptcy orders and house repossessions. The details of every loan, credit card or other credit agreement that an individual has or has had are recorded in these files, which builds up a picture of how much the individual has borrowed and how good they are at making the required monthly payments. The credit reference agencies themselves do not make decisions on whether or not customers should be granted a loan and they do not keep a ‘blacklist’; they simply supply information to lenders on request.
What can a lender view on a person’s credit history?
Every time a person applies for a borrowing product, the lender will search the credit file, and this search leaves an electronic ‘footprint’ in the person’s personal credit history. If they apply for an unusually large number of loans, a note is put on their record. ‘Shopping around’ for the best loan or mortgage deal can also cause a problem, because lenders may view multiple credit searches by different credit providers as a sign that the individual is finding it hard to get a loan agreed. Making payments late or missing payments, building up payment arrears and defaulting on a loan credit agreement (ie failing to pay it all back) all show up as negative footprints on a person’s record. Many people who have mobile phones on monthly payment contracts do not realise that these too are credit agreements and that, if they miss payments or fail to keep up the payments for the full term of the contract, negative footprints will be added to their credit history.
Can an institution refuse to offer credit?
What can someone do if they are refused credit?
How can poor credit histories be improved?
A financial institution may refuse to offer credit to an applicant if it thinks that the applicant is a bad risk because they have already borrowed too much or because they have a bad history of repaying. If someone is refused credit and thinks that this is unfair, they can check their credit history online at the credit reference agency websites or by writing to the agency and asking to see their file. Poor credit histories can be improved only by consumers repaying their loans, credit cards, etc, on time and in full. You can view snapshots of a sample Experian credit report online at experian.co.uk/creditreports/sample-report.htm.
Which people are sought after by financial institutions?
Customers who repay on time and in full leave favourable financial footprints; these people are sought after by financial institutions. Examples are those people who always pay their loan and mortgage payments on time every month, and individuals who regularly pay more than the minimum payment on their credit card balances every month, by the due date. (People who actually avoid paying any interest on their credit cards by paying off the balance in full every month are not so attractive to credit card companies, of course, because the company will not make any money out of these customers.)
When does debt become a problem?
What happens if people get into so much debt that they cannot pay? This may be because they borrowed too much or because they have now lost their means of earning an income. Debt is a useful financial tool as long as borrowers limit it to what they can afford, taking into account their other expenditure; borrowers have got a problem if they cannot meet the agreed payments without borrowing more money.
When do people typically apply for a consolidation loan?
What is this loan?
When people realise that they can no longer afford to pay the necessary monthly payments on their debts, many react to the situation by applying for a consolidation loan. A consolidation loan provides enough money to pay off all of the other debts. This kind of loan is often secured on the customer’s home, assuming that the applicant is a homeowner and that there is positive equity in that property.
When can a consolidation loan be a good thing?
When can a consolidation loan be a bad thing?
In some cases, a consolidation loan can be a solution to a debt problem, eg if the consolidation loan has a lower interest rate than the existing debts and a longer repayment period, which will further reduce the monthly payment. Debtors should, however, take care to avoid high-interest loans. Some people take out a consolidation loan as a last resort and, if they are desperate to cover their debts, they may not pay enough attention to the interest rates, arrangement fees, other charges and the ‘small print’ – ie the legal terms and conditions attaching to the loan. If they find that they cannot afford to make the required payments on the new loan, it will simply make matters worse – and if that new loan is secured on a property, it could put their home at risk.
What is the first thing people should do if they cannot repay what they owe?
What companies should an individual use?
The first thing that people should do if they cannot repay what they owe is recognise that there is a problem and ask for help. There are many companies that offer debt management advice and services: some companies’ adverts even claim that they can use a ‘legal loophole’ to ‘wipe out 75% of your debts’. But such companies often charge high fees for their services. Paul Lewis, presenter of BBC Radio 4’s Money Box, advises that people with debt problems should never go to a commercial company for help. Instead, he suggests that they use a free service offered by a charity such as Citizens Advice, which provides information and advice online at www.citizensadvice.org.uk, or locally, through its network of Citizens Advice Bureaux.
