Credit cards, loans and arranged overdrafts: borrowing options explained

Borrowing money can be a daunting prospect, not least during periods of economic uncertainty.

If you think borrowing could be right for you at this time, start by asking yourself these questions:

• Why do you need to borrow? – what will you use the money for?
• How much do you need? – try to work out an exact amount if you can, whether it’s for a one-off cost, or to cover expenses over a longer period
• How much can you afford to repay each month? – work this out based on your estimated budget for as far as you can plan ahead 
• How long do you need to borrow for? – based on how much you need and what you can afford to repay, will you be borrowing for a set, or indefinite, period?

Once you’ve answered these questions, you’ll be in a better position to decide which way of borrowing would be most cost effective. Keep in mind, you’ll need to pass eligibility checks to be approved for any of the products below. 

• Arranged overdrafts
• Credit cards
• Loans

Arranged overdrafts let you continue spending money from your current account when your balance reaches £0, or below. You can typically borrow a certain amount in this way interest free. But once you pass that amount, you’ll be charged interest.

An arranged overdraft is there to help if you occasionally go over budget. For example, you could dip into your overdraft to cover your costs until you get paid next.

It’s possible to become over-reliant on an arranged overdraft and use it to cover more than occasional costs. 

Standard interest rates may be higher than on loans and credit cards, so they can be an expensive way to borrow.

You can use a credit card to buy things and pay for them at a later date. If you owe money, you have to make at least a minimum payment – which is usually a percentage of what you owe – each month. 

If you don’t repay the amount you owe in full each month, you’ll typically be charged interest.

You’ll have a credit limit, which means you can spend as much as you need on the card up to that amount.

Credit cards can help you spread the cost of regular, or one-off, purchases. They also provide protection if those purchases go wrong, such as goods being faulty or flights being cancelled. 

And by keeping up with repayments, you can use them to improve your credit rating. 

If you don’t have an emergency fund, credit cards can also provide back-up to cover unexpected costs.

The specific benefits vary according to the type of credit card. For example, some credit cards let you earn points for everyday spending, which you can redeem elsewhere. 

Other types, such as balance transfer and 0% purchase credit cards, offer interest-free periods. These can provide some breathing space on payments, if you use them in the right way.

The amount you owe – money you’ve spent on the card, plus interest – can mount up if you’re not careful. Try to pay back as much as you can each month, ideally all you owe. The more you pay back, the less interest you’ll be charged. 

Avoid late fees by setting up a Direct Debit to cover at least the minimum payment each month. 

If you use a credit card with an interest-free offer, either on balance transfers or purchases, have a plan for when that offer ends, so you can try to avoid being charged interest.

• How to use a balance transfer credit card
• What is a 0% credit card for?
• How to avoid credit card charges

A loan is where you borrow a set amount of money for an agreed amount of time. You pay back the full amount – usually in monthly instalments – plus interest. For most fixed-term loans, the rate of interest is also fixed at the outset and won’t change for the duration of the loan.

The rate of interest is typically lower than for overdrafts, or credit cards.

Loans can allow you to spread the cost of a big purchase. They’re commonly used for buying a car and home improvements, for example. 

They can also be used to consolidate multiple debts into one. With a single monthly repayment and interest rate, this can make debts easier to manage.

It’s really important you can comfortably afford to keep up with your repayments. If you miss a loan repayment, it could impact your credit rating. And if you end up not being able to repay the loan, you could face a county court judgement or bankruptcy. 

If you’re applying for a loan to consolidate other debts, it's important to consider not just the interest rate and monthly repayments, but also the term of the new loan compared to the remaining term of your existing loans or debts. 

Spreading your payments over a longer term means you could end up paying more overall than under your existing arrangements, even if the interest rate on the new loan has a lower rate.

Be aware of loans with high interest rates. For example, payday loans can offer quick access to cash, but you could end up paying back far more than you borrowed. This could make it harder to get out of debt in the long run.