The Law and Interest

VIDEO- Watch this as an introduction to borrowing money.

IMPORTANT FACTS- Borrowing

Young people should ask themselves the following questions before borrowing:

• Do they need to borrow:could they save up or use savings instead?
• Can they afford to borrow?
• Do they still want to borrow after a cooling off period of 2 days?
• If they do decide to borrow, who should they borrow from?

The law on borrowing

You usually need to be over 18 to borrow money.

Firms lending money to customers must be licensed by the Office of Fair Trading (OFT). It requires credit agreements to be set out in a particular way and to contain certain information. Check with the OFT if a firm is licensed, because you are only protected when things go wrong if you have dealt with a licensed firm.

Lenders must state the interest rate, total repayment and how much will have to be paid every month.

Interest rates

When you repay a loan, you also have to pay interest, which is essentially a charge for borrowing. The interest rate is expressed as a percentage of the amount borrowed (the principal).

Annual Percentage Rate (APR)

The APR is a standard way of showing the costs of borrowing, so you can work out which option is the cheapest. It includes the interest rate plus fees or charges to set up the loan.

How to calculate APR

This gadget shows how much you can be expected to pay with particular APRs. It may be in US Dollars but give it a go!

Repaying Loans

Cost of borrowing and repayment options

How much you’ll pay to borrow money depends on how much you need and how quickly you plan to repay it. For example, if you want to borrow a small amount over a short period of time with a low interest rate, you may well pay very little interest (or none at all if you use a credit card charging 0% interest). On the other hand, borrowing a large amount of money over a long time will cost you more. You should consider whether you want to pay regular payments or flexible payments.

Secured vs. unsecured loans

Secured loans are loans which are secured against an asset. For example, a mortgage is usually secured against the house you are paying for - so if you stop paying back the mortgage, the bank can take away your house (commonly known as repossession). Secured loans are often used to borrow large sums of money, typically of more than £10,000, although sometimes you might be able to borrow as little as £3,000.

Collateral is the asset against which the loan is secured. So for example, the collateral of a mortgage would be the house.

Unsecured loan is where there is no asset to back up the loan. Unsecured loans carry more risk for the lender, which in turn makes the loan more expensive. The more additional risk that a lender must take on, the higher the rate of interest a borrower must pay. If you can't or don't make the payment, the lender can go to court to try and get their money back and your credit rating will be damaged if you fail to pay.

Faith-based rules on interest and borrowing money

The practice of charging interest to borrow money is prohibited in some religions. It is know as riba in Arabic and ribbit in Hewbrew. In English the term usury traditionally meant the charging of interest on loans, but now it is usually used to mean the charging of excessive or illegal interest. This Wikipedia article gives a background of the religious and historic context of usury in Christianity, Judaism and Islam.

Islam

The overarching principle of Islamic finance is that all forms of interest are forbidden. This means that Muslims can only use non interest-bearing or 'Shariah compliant' financial products. The Islamic financial model works on the basis of risk sharing, meaning that the customer and bank share the risk of any investment on agreed terms, and divide any profits or losses between them. Investments should only support practices that are not forbidden: trades in alcohol, betting and pornography are not allowed. Moreover, an Islamic banking institution is not permitted to lend to other banks at interest. Many financial products and services which are permissible in Islam, such as Shariah compliant credit cards, are available in the UK, both from high street and Islamic banks.See the FSA for more details.

Judaism

Jewish law, also known as 'halacha', teaches that 'any reward for waiting is forbidden', meaning that interest should not be paid to lenders. Orthodox Jews are also forbidden to borrow money without a specific play to repay their debt. Orthodox Jews are also forbidden from borrowing money without a specific plan to repay that debt. See this article for more details.