Borrowing smart in a debt-filled world is essential if you want to stay on top of your finances – and it’s easier than you might think.
With interest rates at an all-time low, there has never been a better time to borrow (rates were 0.25% in the UK, 0.5% in Canada, 1% in the US and 1.5% in Australia on 20 March 2017).
Whether it’s for a house or a car or to start your own business, money is cheap. So if you’re planning an investment, make the most of it.
With interest rates so low, and inflation starting to rise, the only direction rates are going to up. Here are some options worth considering:
1. Switch to a long-term mortgage deal
If your mortgage is coming up for renewal, consider moving to a five-year fixed rate deal, which are available from about 2%. The monthly repayments will be higher, but as rates start to rise you will reap the benefits.
A two- or three-year fix, while cheaper up front, could bring a nasty surprise when you come to renew.
2. Remortgage to free up equity
If your home is now worth substantially more than when you bought it, look at increasing the size of your mortgage to free up cash for home improvements or other major projects, as an alternative to a bank loan.
Say you paid £200,000 for the property with a £160,000 mortgage. You have paid off £10,000, but your home is now worth £250,000, leaving £100,000 in equity you could tap into. If you borrowed an extra £20,000, taking your mortgage to £170,000, you would have a loan to value (LTV) of 67% – still less than the original LTV of 80%.
This looks attractive with mortgage rates so low, but remember they are likely to rise. Also, lenders frown on cash raised this way being spent on ‘frivolous’ outgoings such as holidays.
If for any reason you struggle to meet the repayments, your home could be repossessed.
3. Invest in property
If you are looking for a sound medium-term investment, this could be a smart way of raising cash while interest rates are low – depending on where you are in the world.
In countries such as the UK, house price rises generally outperform interest rates by a considerable margin, and buying to let has become a popular investment.
The government increased stamp duty – the purchase tax on this type of buying – in 2016, but with interest-only mortgage rates at record lows of around 1.5%, this still represents smart borrowing – and the interest is tax deductible.
There is a potential headwind in the UK with Brexit taking place, but such is the shortage of homes in the UK that unless there’s another economic catastrophe such as the 2007-08 banking crisis, values are only likely to rise.
If you can’t afford to buy on your own, consider teaming up with friends or family and getting a mortgage together – known as ‘tenants in common’.
You will need a deposit of roughly 25% of the property’s value, and you will also need to allow not just for initial building work to bring it up to scratch for letting, but also for annual maintenance.
However, be sure you know your partner(s) extremely well, consider them to be 100% trustworthy, and that your exit strategies are aligned, or it could all go horribly wrong.
If you want to borrow money to start your own business, build a new house or fund your band’s new album, forget expensive and hard-to-get bank loans – there’s a new kid on the block.
Crowdfunding has become an incredibly popular way to raise cash, using the power of the internet. Individuals can pledge money to back your project in a safe environment in exchange for a variety of rewards.
One couple featured in Channel 4’s Grand Designs programme raised £60,000 to help fund a shortfall in their self-build project. Mark and Candida Diacono offered perks such as visits to their smallholding or an invite to the launch party, and raised the cash in just 28 days.
Meanwhile, crowdfunding site pledgemusic.com gives bands the chance to fund albums and engage with a new audience, who in exchange get treats such as signed CDs, VIP passes and digital downloads.
There’s even a crowdfunding site – unbound.com – for aspiring authors.
5. Borrow from friends and family
Another option if you’re looking to raise cash to start a business is to ask friends and family to back you. But this should not be undertaken lightly.
If the venture fails, you need to be in a position to pay them back, unless they are happy to make a no-strings investment in exchange for equity.
Either way, you don’t want relationships to go sour. Do your business planning thoroughly, and run the plan past an independent business adviser to get a critical appraisal.
6. Release cash in your pension
If you are over 55 you can now release up to 25% of the cash from your pension as a tax-free lump sum. That could add up to quite a substantial amount of money to invest while interest rates are low.
But remember: what you take now, you can’t have later. Anything over 25% would be taxed at your normal income tax rate.
7. Set up a margin account
If you have a good understanding of the financial markets but lack the cash to make investments, you can set up an account with a stockbroker that allows you to borrow cash to invest. This is known as a margin account.
However, it can be an extremely risky strategy if you use the cash to make speculative investments. You could end up making substantial losses, not just on the shares you trade, but the interest on the funds you borrowed to make those trades.
Not for someone with limited knowledge of the markets.
8. Equity release
This used to be an act of last resort if you were retired and owned property, but were cash poor. Equity release allows you to release cash in your own home while continuing to live there, providing either a lump sum or a regular income.
Interest rates used to be punitive – anything from 7% to 15% – and that equity was soon gobbled up. However, in the current low interest-rate environment, deals of 4.5% to 5.5% are common.
Still substantially more than a normal mortgage, but worth considering if you need some cash, are past the cut-off age to qualify for a mortgage (around 70 years of age), and don’t want to move home. Just read the small print carefully.
9. Use savings
If you are making a large purchase, whether it be £500 on a new washing machine or £5,000 on a new car, consider using your savings rather than putting it on your credit card or taking out a loan.
With bank interest rates at less than 1%, credit card interest at 18%-35%, and personal loans at around 5%-7%, you don’t need to be Einstein to work out which is the better deal.
But never use your savings just to fund a lavish lifestyle – and always keep something back for a rainy day.
As always, never borrow money you cannot afford to repay, and budget for those interest rate increases that will inevitably arrive.