What You Need to Learn
- Understand reasons why people borrow money and distinguish good debt from bad debt
- Know the scale of UK personal debt and trends over time
- Understand APR (Annual Percentage Rate) and how to use it to compare borrowing costs
- Know the key features of mortgages, personal loans, credit cards, overdrafts, store cards, hire purchase, credit unions, and payday loans
- Compare the advantages and disadvantages of different borrowing products
10.1 Why People Borrow
Most people need to borrow money at some point in their lives. Very few people can afford to buy a house or a car outright, so borrowing allows them to spread the cost over time. However, not all borrowing is sensible.
Essential vs Non-Essential Borrowing
| Essential Borrowing | Non-Essential Borrowing |
|---|---|
| Buying a house (mortgage) | Holiday abroad |
| Buying a car needed for work | Latest smartphone or gadget |
| Funding education or training | Designer clothing |
| Emergency home repairs (e.g. broken boiler) | Eating out at expensive restaurants |
| Starting a business | Concert tickets or gaming consoles |
Good Debt vs Bad Debt
Good Debt
Borrowing to buy something that will increase in value or improve your earning ability over time.
- Mortgage — property usually increases in value
- Student loan — education can lead to higher earnings
- Business loan — investment that may generate income
Bad Debt
Borrowing to buy something that loses value quickly or that you could have saved up for instead.
- Payday loan for a holiday — very high interest for a non-essential
- Credit card for designer clothes — clothes lose value immediately
- Store card for electronics — high interest rate, items depreciate
Activity: Good Debt or Bad Debt?
Sort each borrowing scenario into "Good Debt" or "Bad Debt":
10.2 UK Personal Debt
The UK has one of the highest levels of personal debt in the world. Understanding the scale of the problem helps explain why financial education is so important.
UK Debt Statistics
| Measure | Figure |
|---|---|
| Total UK household debt | Over £1.8 trillion |
| Average household debt (including mortgages) | Approximately £65,000 |
| Average household debt (excluding mortgages) | Approximately £4,000 |
| Total credit card debt in the UK | Over £67 billion |
| Number of people in problem debt | Around 8 million people |
| One person is declared bankrupt or insolvent every | Approximately 4.5 minutes |
Why Has UK Debt Increased?
- Easy access to credit — credit cards, online lending, and buy-now-pay-later services make borrowing very simple
- Rising house prices — people need larger mortgages to buy homes
- Cost of living increases — prices rising faster than wages means people borrow to cover essentials
- Consumer culture — social media and advertising encourage spending on wants rather than needs
- Low interest rates (historically) — cheap borrowing encouraged people to take on more debt
10.3 The Cost of Borrowing
When you borrow money, you pay back more than you borrowed. The extra amount is interest — the price the lender charges for letting you use their money.
APR — Annual Percentage Rate
APR stands for Annual Percentage Rate. It is the standardised way of showing the cost of borrowing, making it easier to compare different products fairly.
- The interest rate charged on the loan
- Any compulsory fees (arrangement fees, admin charges)
- Expressed as a yearly percentage, even if the loan is shorter or longer than a year
Comparing Using APR
Example: Borrowing £5,000 Over 3 Years
| Lender | APR | Monthly Payment | Total Repaid | Total Interest |
|---|---|---|---|---|
| Bank A | 5.9% | £151.89 | £5,468 | £468 |
| Bank B | 9.9% | £161.33 | £5,808 | £808 |
| Online Lender C | 19.9% | £185.56 | £6,680 | £1,680 |
Conclusion: Choosing the lowest APR saves £1,212 in interest compared to the highest APR lender. Always compare APRs before borrowing.
Total Cost of Credit
The total cost of credit is the total amount you repay minus the amount you originally borrowed. It shows you exactly how much the borrowing costs you in money terms.
Example: You borrow £5,000 and repay £5,808 over 3 years. Total cost of credit = £5,808 − £5,000 = £808
Quick Check: APR
10.4 Borrowing Products
There are many different ways to borrow money. Each product has different features, costs, and risks. Choosing the right product for your situation is essential.
Mortgages
A mortgage is a long-term secured loan used to buy property. "Secured" means the lender can repossess (take back) the property if you stop making payments.
| Feature | Detail |
|---|---|
| Typical term | 25–30 years |
| Security | The property itself — lender can repossess if payments are missed |
| Interest rates | Lower than unsecured loans (typically 4–7% APR) because the lender has security |
| LTV (Loan to Value) | The mortgage amount as a percentage of the property value. E.g. £180,000 mortgage on a £200,000 house = 90% LTV |
Repayment Mortgage
Each monthly payment covers interest AND part of the original loan. At the end of the term, you own the property outright. This is the most common type.
Interest-Only Mortgage
You only pay the interest each month. The original loan amount is still owed at the end. You must have a plan to repay it (e.g. savings, investments). Monthly payments are lower, but riskier.
Fixed Rate
Interest rate stays the same for a set period (e.g. 2 or 5 years). Monthly payments are predictable. Good when interest rates are expected to rise.
Variable Rate
Interest rate can go up or down with the Bank of England base rate. Payments may change. Can be cheaper than fixed, but less predictable.
Personal Loans
| Feature | Detail |
|---|---|
| Type | Unsecured — no asset tied to the loan |
| Typical term | 1–5 years |
| Payments | Fixed monthly payments — you know exactly what you owe each month |
| Interest | Higher than mortgages (typically 3–15% APR) because there is no security for the lender |
| Common uses | Car purchase, home improvements, debt consolidation |
Credit Cards
A credit card provides revolving credit — you can borrow up to a set limit, repay it, and borrow again.
| Feature | Detail |
|---|---|
| Credit limit | The maximum you can borrow (e.g. £2,000) |
| Interest-free period | If you pay off the FULL balance each month, you pay NO interest (typically up to 56 days) |
| Minimum payment | The smallest amount you must pay each month (usually 1–2.5% of the balance or £5) |
| Typical APR | 18–25% APR (very expensive if not paid off in full each month) |
| 0% promotional rates | Some cards offer 0% interest for a set period (e.g. 12–24 months) on purchases or balance transfers |
Overdrafts
| Type | Description | Cost |
|---|---|---|
| Arranged (authorised) overdraft | Agreed in advance with your bank — you can spend up to the agreed limit even if your account reaches £0 | Interest charged (typically around 40% APR), but usually no penalty fees |
| Unarranged (unauthorised) overdraft | Going overdrawn without agreement or exceeding your arranged limit | Higher interest rate and possibly refused transactions; can damage your credit score |
Store Cards
Store cards work like credit cards but can only be used in one retailer (e.g. Topshop, Debenhams). They usually offer a discount on your first purchase (e.g. 10–20% off) but charge very high interest rates — typically 25–30% APR, much higher than most credit cards.
Hire Purchase (HP)
Hire purchase allows you to buy goods in instalments. You pay a deposit, then make fixed monthly payments. You do not own the goods until you have made the final payment.
- Common for cars, furniture, and appliances
- Fixed interest rate — you know the total cost from the start
- If you miss payments, the goods can be repossessed
- Ownership transfers to you only after the last payment
Credit Unions
A credit union is a not-for-profit financial cooperative owned by its members. They offer low-cost savings and loans to their members.
| Feature | Detail |
|---|---|
| Maximum APR | 42.6% APR — capped by law (much lower than payday lenders) |
| Membership | Based on a "common bond" — e.g. living in the same area, working for the same employer, or belonging to the same community group |
| Philosophy | Members save together and lend to each other; profits returned to members as dividends |
| Advantage over payday lenders | Much lower interest rates and no hidden fees; they also encourage responsible saving |
Payday Loans
Payday loans are short-term, high-cost loans designed to bridge the gap until your next payday. They are the most expensive form of borrowing.
Example: The Cost of a Payday Loan
Sarah borrows £200 for 30 days from a payday lender:
| Amount borrowed | £200 |
| Daily interest (0.8%) | £1.60 per day |
| Interest over 30 days | £48 |
| Total repayable | £248 |
Sarah pays £48 in interest for borrowing £200 for just one month. If she borrowed £200 on a credit card at 20% APR for the same period, she would pay approximately £3.30 in interest — 14 times less.
Activity: Match the Borrowing Product
Match each borrowing product with its key feature:
Activity: True or False - Borrowing Products
Activity: Fill in the Blanks
Flip Cards: Key Terms
Click each card to reveal the definition:
Practice Quiz
Test yourself with these exam-style questions:
Summary
| Borrowing Product | Key Features to Remember |
|---|---|
| Mortgage | Secured on property; 25–30 year term; lowest interest rates; repayment or interest-only; fixed or variable rate |
| Personal loan | Unsecured; 1–5 year term; fixed monthly payments; higher interest than mortgage |
| Credit card | Revolving credit; interest-free if paid in full monthly; minimum payment trap; 18–25% APR |
| Overdraft | Arranged vs unarranged; short-term emergency use only; around 40% APR |
| Store card | Very high APR (25–30%); initial discount but expensive long-term |
| Hire purchase | Pay in instalments; do not own goods until final payment; common for cars |
| Credit union | Not-for-profit; max 42.6% APR; community-based; ethical alternative to payday lenders |
| Payday loan | Very high cost (1,000%+ APR); short-term only; debt spiral risk; absolute last resort |
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