Types of borrowing and credit scores

Types of borrowing and credit scores

Borrowing is an agreement to receive money and to repay it in full, on time and paying interest according to an agreed schedule. Debt is another word for borrowing. Credit describes how much money you have, or are believed to have, access to. The most common types of borrowing are shown in the table below:

The table above was compiled from lending organisations. Details are liable to change not just over time, but also with the size of sums borrowed, the length of time they are borrowed for (the “term”), the provider, repayment method and the credit standing of a borrower. A good way to compare interest rates is to check an APR, or annual percentage rate, which standardises the calculation of interest rates and takes account of any fees.

Bank overdrafts and payday loans are for short-term borrowing. The expense of payday and doorstep loans reflects poor repayment experience. All types of borrowing with the word loan in them and hire purchase agreements reflect a legal contract to repay in scheduled instalments. Overdrafts and credit cards are more flexible but, because there is no regular obligation to reduce meaningfully the sum borrowed, they can work out very expensive. With hire purchase you only own the item being acquired after the final payment. In this example, the car manufacturer set an attractive interest rate.

Interest rates tend to reflect how a lender sees risk. In general, the longer a loan lasts, the riskier it is, because over a longer period events may occur which make it hard for a borrower to complete repayment. In the near term, it is more likely that a recently approved borrower can make the planned repayments. However, if a borrower is willing to pay a high rate of interest, they may be a risky client, desperate for money, and could struggle to repay a debt.

Lenders may use credit scores to help assess borrowers. Each company performing credit scores makes its own assessment, so different companies do not always reach identical conclusions. Refusal or a poor score by one company does not automatically mean refusal or an equally poor score by another. There are ways of improving credit scores. They may include being on an electoral roll, getting a landline, updating or cancelling old accounts, never missing payments or reducing your debts. You can ask to see and, if necessary, correct the details contributing to your score. A statutory credit report is available free from the three main credit scorers, CallCredit, Equifax and Experian.

For more information, see Citizens Advice national website on types of borrowing

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