Learning the basics about debt

Debt can be your friend or your foe.

So, you’re here because you understand the importance of educating yourself about debt and finance. Good move. Debt can be your friend or your foe. If you utilise borrowing wisely it can make you a lot of money. The unfortunate thing is that so many people get caught up in the trap that borrowing can set. If you fall into the trap, it can be difficult to get out without any consequences.

Let’s start from the top...

Banks need to lend money

You may not realise this, but a most of a bank’s income comes from interest and fees. Interest is generated from loans created by the bank, so it’s in the banks interest to lend money. That’s why an 18-year-old may find themselves being offered a personal loan, even before they have a fulltime job or built up any credit history.

It doesn’t matter how bad your credit file is, there are so many lenders in the market that it is very hard to not find at least one who will agree to lend you money. It may, however, cost you substantially more than someone who has a high credit score. If you have a poor credit rating, you are seen as risk. The lender will want to make the risk worth their while and will be aware that your options are few.

Canvasing for business

Understanding the above is an important starting point. Knowing this will help you understand that banks and lenders are businesses, just like any other business، for example, Amazon.

In the same way that Amazon will send you offers all the time to encourage you to buy, banks and other lenders will send you offers to encourage you to borrow. You are a customer to them; they want your continuous business. Amazon may send you an email suggesting an item like a Dyson vacuum cleaner. You didn’t search for a Dyson on Amazon, and you never felt you needed one. However, you will still receive the email to entice you to buy. Banks and lenders work the same way, you didn’t ask for a loan or a credit card you didn’t search for them neither. However, the banks and other lenders may send you an email or letter to entice you.

New business is important for any business, most people in the UK have some sort of borrowing, usually with the bank that receives their income. A bank account is needed in the UK to receive income therefore, as you must be 16 years or older to have a bank account, banks will provide attractive offers to 16-year-olds to open an account with them.

If at the age of 18 the account holder is eligible to borrow, there’s a high chance they will borrow from the same bank that receives their income.

Repeat business

The business of banks and lenders is lending, they still need to make money, even when it’s a risk.

The Real Debt Guy

Like any other business, repeat business is something a bank or lender strives for. You can pay off a personal loan, but don’t be surprised if an offer for another one arrives shortly after.

Lending money is a competitive business, so banks and lenders need to make sure you don’t take your business elsewhere. If you've borrowed before they tend to believe you will borrow again. If you default on a debt, the default will sit on your credit file for six years.

Negative marks will affect your ability to borrow, well it’s supposed to... However, many people have received offers to borrow money or take out a credit card whilst marks like CCJ’s are still on their credit file. The business of banks and lenders is lending, they still need to make money, even when it’s a risk.

Maximising income

When you walk into a fast-food restaurant like McDonalds you probably have an idea of what you want. It could be a Big Mac meal; this is what you fancy. The person taking your order will likely ask you if you want to supersize the meal or if you want to add an apple pie to the order. The person taking your order is trained to maximise the income from your visit.

In the same way, don’t be surprised if you have a credit card with a bank and you are spending heavily on it, only to be offered a higher credit limit. The more you spend the more interest the bank can generate, specifically if you are only making minimum payments. Banks can maximise their income by providing you with more to spend i.e., giving you a higher credit limit. If you are unable to manage a higher credit limit you should never accept one. You can refuse it. If a bank automatically increases your credit limit you can ask for the increase to be removed.

When is debt your foe?

Debt becomes a problem when you are borrowing to subsidise your general day to day spending. This shows that you are living outside of your means. It is not something that is sustainable long term. The sooner you address this the better, nip it in the bud before it spirals out of control. Our budget planner is a tool that everyone should be using regularly in order to stay living within your means. If you do not know what you are spending and you are using credit to keep you afloat each month, you are at high risk of financial difficulty.

Budget planner.

Do you know how much you have left at the end of each month? Do you need to send an income and expenditure to a creditor? We've got you covered. Our budget planner provides you with a simple and free way to view and track your spending.

When is debt your friend?

When borrowing makes you money, that’s when debt is your friend. It’s important to learn the term leverage. If you take out borrowing in the form of a mortgage, you sell the property and make £50,000 after paying back the mortgage, interest and any fees if applicable. Debt has been your friend; you’ve used bank money to make you money. We always recommend that you try and restrict your borrowing to projects or investments that will turn a profit. It’s not always easy to do this but having the mindset of “how will borrowing this money benefit me financially” will help prevent you from debt becoming your foe.

Learn the rules of the game

It’s so important to understand a subject that plays a crucial role in all our lives. This will hopefully kick start your learning in this subject. Never take part in a game without understanding the rules. Now you’re done here, head to another article in our Financial Education section by clicking here and continue to gain more knowledge that will not only help you but others too.