Rising cost of living leads to more families borrowing. Here’s what to consider before you increase debt levels

The soaring cost of living is placing pressure on many household budgets. Figures suggest that some are turning to borrowing to help bridge the gap. However, this solution may not be sustainable, and you should consider what’s responsible if you’re increasing loans, credit cards, or other forms of borrowing.

In the 12 months to September 2022, the rate of inflation was 10.1%. This is significantly higher than the Bank of England’s (BoE) 2% target. While many things are influencing the higher rate of inflation, increasing energy and food prices are playing a role. As a result, many households are finding their budget is stretched.

Consumer credit has increased by 7% in the year to August 2022

Data from the BoE indicates that many families are turning to borrowing to fill an income gap.

The August Money and Credit report shows that the annual growth rate for all consumer credit was 7% in August – the highest rate since March 2019. Credit card borrowing accounted for a large proportion of this with a 12.9% increase.

During the month, individuals borrowed an additional £1.1 billion in consumer credit, following £1.5 billion of additional credit in July. This is above the 12-month pre-pandemic average of £1 billion.

In contrast, the amount families are depositing in banks and building societies is falling. In August, people added £3.2 billion to accounts across the UK, compared to £3.9 billion in July.

If you’re struggling to make your budget stretch further as the cost of living rises, borrowing to bridge the gap may seem like a simple solution. You can often apply for credit online, from an overdraft to a personal loan, and receive a response within minutes.

However, access to easy credit can mean you make decisions without fully thinking them through.

5 questions to answer before you increase your credit

1. How will you use the money?

Setting out why you’d like to borrow money can help you figure out if it’s the right option for you.

Would you use the money to pay for a one-off cost, or to support your ongoing expenses? If you’re thinking about borrowing to support regular outgoings, it could make your situation worse long term.

How much money do you need to reach your goal? With a clear view of what you want the money for, you can set out a realistic budget and understand what type of credit may be right for you.

2. Can you take advantage of any introductory offers?

There may be introductory offers that you could use to make borrowing more affordable.

For example, there are credit cards that offer 0% interest rates for purchases or balance transfers for a defined period. If you can fully repay the amount borrowed within this time frame, you won’t pay interest. However, the interest rate will often be higher after the introductory period has ended.

You will usually need a good credit score to access these offers.

3. What will the interest rate be?

The interest rate will affect how much it costs you to borrow the money overall and your repayments. So, it’s an essential figure you need to know. Even a small difference can add up.

If you borrowed £20,000 through a personal loan over 10 years, the below highlights how different interest rates will affect your monthly repayments:

4%: £201.81

6%: £220.45

8%: £239.72

10%: £259.55

Source: MoneySuperMarket

Usually, the better your credit score, the more likely it is you’ll receive a competitive interest rate.

4. How much will your minimum repayments be?

Before making any financial commitment, you should be confident in your ability to meet it. Make sure you understand what the repayments will be and how they will fit into your budget.

Keep in mind that making the minimum payments will mean it takes you longer to pay off the debt and cost more in interest.

5. What are your alternative options?

Review all your options before you apply for credit. In some cases, adjusting your outgoings or dipping into a savings account can make more sense. Look at your current circumstances in the context of your wider financial plan to understand what alternatives may be available.

Take your time reviewing your options. Applying for credit could affect your credit score

Lenders use your credit score and report to assess how much risk you pose when reviewing your application.

When you apply for credit, a hard credit search will usually be carried out, which will show up on your credit report. Several applications in a short period, whether they’re accepted or not, could harm your score and act as a red flag to potential lenders.

So, rather than applying for the first credit card or loan you find, take your time to do some research. Ensure you match the criteria of the lender, and the terms suit you before you apply.

Do you want to review your financial plan as the cost of living rises?

As costs rise, you may have questions about what it means for your financial plan. Whether you’re thinking about extending how much credit you have or aren’t sure how to make the most of your assets, please contact us to discuss your options.