Avoid these borrowing blunders!

Most of us borrow money at some point, so here's how to escape the traps and hang onto more cash.

"Neither a borrower nor a lender be;

For loan oft loses both itself and friend,

And borrowing dulls the edge of husbandry."

(spoken by Polonius in Act I, Scene III of Hamlet by William Shakespeare)

Some sound advice there from the Bard of Avon!

Sadly, in our modern, money-centred world, it's hard to get through life without borrowing at times. What's more, all forms of borrowing are not equally harmful. For example, student loans enable young people to improve themselves through tertiary education, and mortgages enable aspiring homeowners to live out their dreams -- and buy an asset which tends to increase in value over time.

Indeed, being a lender can be a good thing, too. For example, I lend money via online lending exchange Zopa to people who want personal loans. Not only does this give me higher returns than I would earn in a savings account, but I also get a kick out of rescuing people from the hands of greedy banks! 

Still, having been on epic borrowing binges in the past, I've taken a lifetime vow not to "do debt". Actually, that's not strictly true, because I am prepared to take advantage of interest-free credit (such as the wonderful 0% credit cards) when it suits me to do so.

Other than that, I steer clear of going into the red.

Anyway, as a former borrowing addict, here's my guide to dodging the downsides of debt:

1. Credit and store cards

They are debt cards, not credit cards

The first big error that people make with credit cards is mistaking their credit limit for a target. Indeed, according to debt charity Credit Action, using a credit card can make you spend more - up to a third (34%) more, it estimates. So my first lesson is that you don't have credit and debit cards in your purse/wallet: what you actually have are debt and debit cards!

You don't have to pay interest

The second big blunder is to pay too much interest on your credit- and store-card balances. A typical credit card will charge a standard interest rate of 16%+ APR; for store cards, the rate can be twice as high.

Let me put this into context: at an annual rate of 16%, thanks to interest alone, your debt doubles every four years and eight months. Hence, if you're paying interest on your credit and store cards, it's high time that you jumped on the 0% bandwagon. 

Minimum monthly repayments are lethal

If you can only afford to pay the minimum monthly repayments (MMRs) demanded by your credit cards, then you're in a very bad way. As we revealed in This dangerous mistake could cost you £10,000, by paying the minimum 2% a month on a debt of £2,500, with an interest rate of 18.9%, it can take you 50 years to pay off, and you'd pay out £7,582.38 in interest! Aargh!

Instead of paying MMRs, set up a monthly direct debit or standing order for, say, 1/25th of your balance, which is a flat 4% a month. Even such a modest, fixed amount will pay off most debts within three years.

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2. Mortgages

Don't overstretch yourself

Again, the big howler with home loans is to borrow more than you can comfortably afford to repay. We Brits have enjoyed a fairly lengthy period of low interest rates, which has fooled some people into overlooking the likelihood of future interest-rate rises.

Don't be fooled by eye-catching interest rates

The second slip-up is to focus on attention-grabbing interest rates or monthly repayments, while ignoring the bigger picture. All but a few home loans come with additional fees and charges attached. These can add thousands of pounds to the cost of your mortgage. Hence, my advice is to use an independent, no-fee mortgage broker to search the market and find you the best deal. You can easily do this using the lovemoney.com mortgage service.

3. Overdrafts

For emergency use only

The big bloomer with overdrafts is to rely on one in the first place. Yet so many of us do just this, with many of us being permanently overdrawn.  

In short, an overdraft should only be used to cope with emergency cash-flow troubles; it is not a crutch to support an over-spending habit. If you spend several months of each year in the red, then this suggests that there is a major imbalance between your income and your outgoings. Thus, you need to pull in your horns, curb your spending and learn how to budget. Otherwise, you'll pay hefty rates of interest while you're in the red, plus shockingly high fines for breaching your borrowing limit!

Fancy a better bank account? Then visit our current accounts centre!

4. Personal loans

Take your time and shop around

Personal loans sure are in demand: we Brits take out around 6½ million of them each year. Many are arranged in order to fund a costly purchase, such as a car, holiday or home improvements. Others are used for more exotic means, such as paying for cosmetic surgery or a divorce.

However, a hefty number are consolidation loans, through which borrowers roll up their existing debts into "one affordable monthly repayment". Alas, debt consolidation often backfires, as I cautioned in Borrow enough to get out of debt.

5. Secured loans and second mortgages

Just don't go there, my friend. Seriously, don't! With unsecured personal loans available at under 8% APR, why put your house on the line by arranging a secured loan? Here's a scary thought: every single property that I saw repossessed in court in the early Nineties had a second loan secured on it in addition to a home-buyer mortgage. 

This is a classic article which has recently been updated.

More: New 15 months at 0% interest cards | Four top personal loans