Student life can be an expensive business. If you’re heading off to college in September, you’ll probably be budgeting for your rent, bills, and spending money for the first time.
Many undergraduates find that their bursary doesn’t cover all of their costs – so they look to other ways to borrow money.
But certain types of debt should be avoided. Making the wrong choices at 18 or 19 can have serious repercussions on your financial future. It is therefore important to understand your options and make the right choices.
Here are five types of borrowing students should avoid:
1. Buy now, pay later (BNPL)
BNPL companies such as Klarna, Clearpay and Laybuy often market their payment options as “interest free”. Technically, it’s true – you can usually either pay for your purchases in installments or delay payment for 30 days and pay no interest.
However, these options, combined with clever marketing, make it easy to forget that BNPL is a type of credit.
Students may experience issues if they have to juggle payments for multiple BNPL purchases or multiple accounts with different BNPL lenders. If you miss a payment, the BNPL lender may ultimately transfer the debt to a debt collection agency – this will incur additional charges.
Missed or late payments can also impact your credit score. As of June 1, 2022, Klarna reports paid and unpaid accounts to credit reference agencies Experian and TransUnion. A black mark on your credit report will affect your chances of getting other credit, such as a mortgage, in the future.
2. Payday Loans
Payday loans are relatively small loans designed to be paid off on your next payday. But despite the fact that most students don’t have paid jobs and won’t have a “salary”, there are still a disturbing number of payday lenders targeting students.
Although the cost of payday loans is now capped under rules set by the Financial Conduct Authority (FCA), these loans are still an expensive way to borrow. Someone who takes out a loan for 30 days can pay up to £24 in fees and charges per £100 borrowed. If you don’t repay on time, you could be slapped with a £15 default charge.
These sums may not seem like a lot, but when calculated as an APR, they can reach four figures. Payments are often made through a Continuous Payment Authority (CPA) to your bank card – this could cause problems if you prefer to prioritize other bills or debts.
3. Credit cards
Credit cards are a convenient way to borrow money because they offer flexibility. You can borrow up to your credit limit and, provided you make the minimum monthly payment, repay the debt when it suits you.
But the credit cards available to students tend to be expensive, and they won’t include the 0% interest promotions available to other borrowers.
HSBC and TSB are the only banks to offer student credit cards and in both cases you will need to have a student bank account with the same bank to be accepted.
The HSBC student credit card has an APR (annual percentage rate) of 18.9% (variable) and a credit limit of up to £500, while the TSB card has an APR of 21.95% ( variable) and a credit limit of up to £1,000. .
Interest charges can add up quickly if you don’t pay off your credit card. For example, if you borrowed £1,000 on the TSB card and repaid £20 a month, it would take you nine years and one month to pay off the debt and cost you £1,162 in interest.
Some subprime lenders also offer student credit cards – and these have crippling interest rates. Ocean Finance and Vanquis have APRs of 39.9% and 59.9% respectively. These cards are very expensive, so students should avoid them.
4. Online credit accounts
In the past, retailers gave out store cards to their customers in an attempt to build loyalty. Store cards were a type of credit card that could usually only be used at one retailer. Most offered a discount on your initial purchase, but had higher interest rates than regular credit cards.
But, as consumers shift to online shopping, most store cards have disappeared. Instead, shoppers are encouraged to open online “credit accounts” that work the same way – just minus a physical card.
For example, Very.co.uk offers Very Pay which tempts customers with 20% off their first purchase. It offers various payment options, including the “monthly payment” which has a typical APR of 39.9% (variable).
Both JD Williams and Fashion World offer credit accounts with a typical APR of 39.9%, while Next Pay has a typical APR of 23.9% – both variable.
Students should avoid store credit accounts whenever possible – save for what you want to buy instead.
5. Unauthorized overdrafts
An overdraft occurs when the bank allows you to spend more money than you actually have in your account, up to a previously agreed amount. Student bank accounts all offer a certain overdraft amount at 0% interest. Interest-free overdrafts are the cheapest way to borrow money – remember you’ll have to pay it back at some point.
In the past, many students ran into trouble when they went over their overdraft limit, as interest rates on “unauthorized” or unarranged overdrafts were typically around 40%.
But that’s not really a big deal now. New rules introduced by the Financial Conduct Authority (FCA) in April 2020 mean that banks can no longer charge higher fees for unauthorized overdrafts. Instead, interest on all overdrafts is charged at a single interest rate.
Therefore, most banks simply do not allow students to have an unauthorized overdraft – if you try to exceed your overdraft limit, your payment will be rejected.