Interest-free credit, reward credit cards, overdrafts: the smart and stupid ways to borrow

Having to borrow isn't automatically a bad thing – there are smart and not-so-smart ways to make use of credit

It would be lovely if we never had to borrow cash.

Shakespeare may have come up with “Never a borrower nor a lender be” for Hamlet, but let’s be honest, he didn’t have to deal with rising house prices in the commuter belt, did he?

As a result, there are occasions when we have to turn elsewhere to ask for some financial help, whether it’s just for a few quid or something more substantial.

But the truth is that not all forms of credit are equal, and there are good and less good ways ‒ and times ‒ to borrow.

Spreading the payments... sometimes

Borrowing in order to cover a big purchase makes sense for many of us who don’t have the funds upfront.

This is particularly true when you can make use of some form of interest-free credit, as it means that you can pay off the loan in manageable stages, knowing that every penny you repay goes directly towards clearing that debt.

So for example, you might need to pick up a new sofa but you don’t have the cash at hand to cover the cost.

Plenty of stores offer interest-free credit on purchases, and over a decent time frame too. At DFS, for example, you can currently get four years of 0% interest, with nothing to pay in the first year.

As a result, the eye-watering cost of that new couch becomes much more palatable as you are paying it off in small chunks over a lengthy term.

Money-saving techniques that make no sense

Alternatively, you can turn to a 0% credit card.

With a 0% purchase card you enjoy a period of no interest being charged on the purchases you make with that specific card, while with a 0% balance transfer card you can move debt onto that card and enjoy a period of zero interest.

These sorts of cards used to be particularly prevalent, but the difficulties of the pandemic have seen the number of 0% card available fall sharply.

Nonetheless, if you have a decent credit score you should still have a fair amount of choice.

Fail to plan, plan to fail

An interest-free credit card only works though if you plan out precisely how much you need to pay off each month in order to clear the balance by the time the 0% period comes to an end.

Otherwise, you’ll be back in the same position of being charged a significant rate of interest on your debt.

This is an important mindset to have with any form of borrowing ‒ if you have a proper plan over how to pay it off, it will cost you less overall and leave your finances in a better position.

You can view our roundup of the longest 0% balance transfer cards here.

Who gives you extra?

A rewards credit card can be a fantastic way to borrow too. With these cards you get something back every time you spend, whether that’s loyalty points, airmiles or cold, hard cash.

Use them properly and you are effectively getting something free for doing your normal spending.

That’s the catch though ‒ you need to be disciplined and only put your normal spending on there, as rewards cards only pay off if you can clear the balance in full each month.

Otherwise, the interest charged on your outstanding balance will swiftly erode the value of any rewards you build up.

Don’t dip into the red unless it’s free

Overdrafts ‒ particularly unarranged ones ‒ have historically been incredibly expensive ways to borrow, in some cases costing even more in practice than payday loans.

The FCA has revamped the rules covering overdrafts in a bid to make it more transparent what we actually pay when we drop into the red, but what it has really done is demonstrate that unless you have an account that offers an interest-free overdraft, it should be avoided at all costs, whether it’s unarranged or not.

For more, read: 'this can’t be what anyone thinks fair overdrafts look like'.

I’ll pay it off later

There are plenty of occasions when paying off a debt in stages is far from a good idea.

The interest charged on that debt means that over time the actual cost ramps up significantly.

A perfect example here is insurance. When you take out an insurance policy for your home or your car, you’ll be offered two choices: pay the premium upfront or spread the payments over a year.

But with that latter option, you’re actually effectively borrowing the cost of your premium, and then have to pay interest on that balance, which is why the total amount you repay ends up being far more than if you pay it off in one go.

It’s much the same with the arrangement fee charged on many mortgages.

Typically these fees come to more than £1,000 so they are certainly not cheap, but you’ll be given the option of even paying them at the outset or adding them to your mortgage balance.

That may seem a fairly harmless option ‒ what’s another £1,000 on your mortgage? ‒ but you are being charged interest on it for the entirety of your mortgage term.

As a result, that £1,000 fee ends up costing you an awful lot more overall.

Whenever possible, it’s best to pay off these fees or premiums in one go.

And even if you don’t immediately have the cash to hand, it’s worth seeing if you can make use of an interest-free form of credit, such as a credit card, in order to pay off the premium and then clear the balance in stages that way, as it will be significantly cheaper.