If you need to make a big purchase such as a car or holiday, do you tend to save up for what you want or borrow money instead?
With interest rates currently low, borrowing can seem a tempting option, especially if you need to make a purchase quickly. However, you’ll need to be confident you can pay off what you’ve borrowed quickly, or interest charges can quickly mount up.
Here, we weigh up the pros and cons of both saving and borrowing, to help you decide which might be the best option for you.
Do you need to borrow money
If you’re not sure whether you should save towards your goal or borrow money instead, start by getting a clear idea of where you’re at financially.
Many of us don’t give much thought to what we want from our money (and in the current tough climate it’s hard enough to get from one month to the next), or how much we owe and how much we have. You can’t work out the best way to move forward without knowing where you’re starting from.
If, for example, you already have a decent sized savings pot, and taking money out won’t leave you with nothing to cover any unexpected expenses, then using these to fund your purchase is likely to be a no-brainer.
If, however, you don’t have any readily accessible savings and already have existing debts, then rather than borrowing more, ideally you should think about ways you might be able to pay these off first. If you have debts that are charging different rates of interest, pay off the most expensive one first then work your way down your debts until they’ve all been cleared – but make sure you can always pay enough to keep within the terms of the contract on your other debts. This will get your money working in the most efficient way possible. Learn more about managing existing debts in our guide How to take control of your debts.
Of course, paying down your debts can take a long time, so this is a long term option. If you need to borrow to pay for something urgently, make sure you seek out the cheapest possible ways to do this (see below).
You may feel like there’s very little incentive to save when interest rates are so low, but having savings buys you freedom (or at the least, options). It means you can do things like replace your boiler or car without having to take out a loan, if they go wrong or take your time to find a new job if you’re made redundant.
If you don’t need to make your purchase in a particular hurry, then saving up for it is likely to be a better option than borrowing.
Setting up a standing order into an easy access account for a sum that’s affordable can be the best way to get started. Choose an account that makes it a bit difficult for you to get at the money (one that doesn’t come with a cash card, for example), so you have to think before you raid your savings. But make sure that if you find you really can’t do without the cash you won’t be penalised for withdrawals.
If you have money in an ordinary savings account and you’ve not used up your cash ISA allowance, transfer your money into an ISA but beware that some banks and building societies have lower cash ISA interest rates than on comparable taxed savings accounts. If you’re a basic rate taxpayer you may be better off choosing a top paying account and paying tax on the interest. You can find the current best cash ISA rates in our guide Best cash ISA rates – which cash ISAs pay the most interest?
If you’re a non taxpayer and you have money in ordinary taxed accounts you should fill in a form called R85 to make sure that you receive interest tax free in the future. If you want to reclaim tax you’ve already paid, fill in another form, called R40.
Ways to make saving easier
Saving might seem impossible if you barely have any cash left at the end of every month, but budgeting may help you free up some money to put away.
Some people find budgeting really easy and don’t need to draw up a document that helps them plan their spending. Others struggle to keep a lid on spending. If you need extra help, draw up a budget or at least work out how much you have to spend (on things like rent or mortgage, energy bills, insurance etc) and how much is left over for you to save.
If you’re constantly spending more than you earn, keep a spending diary which is simply a record of what you spend, when you spend it and what you spend it on. You will soon identify patterns of spending and where money is slipping through your fingers. Read our article How to save money – 17 money saving tips to see ways you might be able to reduce your outgoings.
Different borrowing options
If you know saving up isn’t going to be an option, perhaps because you need to make a purchase sooner rather than later, then it’s vital to look at the cheapest ways to borrow.
Borrowing from family or friends
You may be able to borrow from family or friends and it may be cheaper and much easier than borrowing from a bank. However, a court may not take a loan from family and friends into account when considering how to divide the finances between you.
Make sure you can pay back any money you’ve borrowed or you could jeopardise the friendship or family relationship.
0% credit card
If you can get a credit card that charges 0% on purchases (especially if the deal runs for quite a long time – say a year or more) you could use it to fund your purchase. Once the 0% deal runs out the interest rate can rise quite sharply, but it might give you the breathing space you need.
Shop around to get a competitive rate on a personal loan. High street banks tend to be uncompetitive, especially on smaller loan sizes (such as up to £2,500 or so). Interest rates are tiered so the more you borrow, the lower the interest rate you pay.
It sounds perverse but you may get a better deal by borrowing slightly more (especially if you want to borrow around £2,500, £5,000 or £7,500, which are key ‘threshold’ levels). You should try and repay the money you don’t need as soon as possible.
Be aware that the interest rate that’s quoted on websites or adverts may not necessarily be the rate you are offered. Find out more about how loans compare to credit cards in our guide Balance transfer credit cards and personal loans compared.
How to work out the true cost of borrowing
If you’re planning to borrow to fund a purchase, whether you’re using a loan, credit card, or other kind of credit agreement, it’s vital to have a clear understanding of exactly how much you’re going to have to pay back overall.
There are certain basics to consider when thinking about how much borrowing will cost you. For example, the shorter the term you choose to pay back what you owe, the higher your monthly payments will be. However, you’ll end up paying much less interest overall if you choose a shorter rather than a longer term, even though your monthly payments will be lower with the latter.
The interest you’re charged on borrowing is expressed as an ‘‘annual percentage rate’ or APR, and shows how much your borrowing will cost you over a year. The lower the APR, the less you’ll pay in interest. Bear in mind there may be other fees to factor in, for example, if you want to pay off what you owe early, and the overall amount you’ll have to pay back will also be affected by the frequency of repayments, and whether you’re making them weekly or monthly.
If you’re borrowing using a credit card, make sure you don’t just make the minimum repayment each month as it will take you ages to clear your balance. UK Finance has a really useful card costs calculator to help you work out how much it will cost you to pay back different amounts over different time frames. Similarly, financial website Moneyfacts.co.uk has a handy Loan Repayment Calculator which can help you work out the true cost of borrowing using a loan.
Can you afford to borrow money?
Once you’ve worked out how much borrowing is likely to cost you, think carefully about whether you’ll be able to afford to keep up with repayments on top of all your other outgoings.
Soaring living costs mean that many people are already finding it difficult to make ends meet, without adding on another monthly or weekly cost. Sit down and go through your bank statement to see how much spare cash you have free at the end of every month. If the answer is nothing or very little, then unless you’re able to make cutbacks, borrowing won’t be the right solution for you.