The Worst Types of Debt to Incur

Debt is something that is seemingly inescapable regardless of where you live. In the UK, this is no different. Aside from the government having a colossal debt of £2.7 trillion, local households in the region are faring no better, averaging a debt of £71,000 per household—a total of more than £2 trillion.

With the UK’s GDP at just over £2.2 trillion, debt on both governmental and personal levels is quickly outpacing the region’s revenue. This is a significant problem for the public, exacerbated by many individuals taking on debts that quickly become unmanageable.

Aside from rising living costs, much of the reason for taking out debt in the wrong form comes from a lack of financial education. While it’s best to avoid debt whenever possible, some are much worse than others and can quickly worsen financial matters. Here, we’ll look at these types of debts and some better alternatives if you really need to take out a loan. 

Payday Loans

In 2023, more than 5.4 million people in the UK opted to apply for a payday loan. These loans, typically ranging from £50 to £1,000, are commonly repayable within a year or less. In essence, they are meant to get you to your next payday, when the loan will be repaid.

Although these loans are easily accessible and commonly don’t require the same level of credit checks as other types, they have significant drawbacks. The most prominent of these is the high interest rates they charge.

Despite the Financial Conduct Authority (FCA) instituting a limit on payday loan costs, providers of these loans still commonly charge the highest rates allowed—currently 0.8% per day. When calculated over a year, due to the nature of compound interest, these loans can result in an annual percentage rate (APR) of nearly 1,500%.

Aside from the high interest rate of these loans, the short repayment terms can also cause additional problems. Finding the funds to repay these loans in a short period can be challenging, leading to extensions on repayments, each of which comes with extra penalties and fees. 

Application for extensions, longer repayments, and high interest rates can quickly create a loan cycle, leading to a debt spiral that can be difficult to recover from. This occurs most commonly when a new payday loan is taken out to repay an existing one.

Credit Cards

Credit cards are one of the most common forms of debt internationally. In the UK, approximately 32.6 million people own and use a credit card, with around 11.6 million daily transactions. These contribute to a combined credit card debt of £71.19 billion across the region. 

One prominent reason credit cards have become so popular is that many offer loyalty or rewards programs. Additionally, access to credit cards has become increasingly easy, with financial institutions encouraging consumers to apply for and use them.

The pitfall of using these cards is that, like payday loans, they often come with excessive interest rates that compound over time. The average credit card APR ranges from 15% to 35%, significantly higher than some other forms of loans. Compounded, this can lead to large amounts being paid in interest alone, with little of your repayments going toward the capital borrowed. 

Another significant downfall of credit cards is their minimum payment levels. While these make using a credit card seem appealing, most minimum payment amounts reflect between 1% and 3% of the outstanding balance. 

Although these low repayments make paying off your credit card manageable, they do little to reduce the actual capital amount owed, with most of your repayment going to interest. This can lead to the debt taking much longer to pay off and excessively high levels of interest paid over the course of payments, sometimes requiring a request to freeze interest to stay up to date on payments. 

Store Accounts

Like credit cards, store accounts are prevalent in the UK. They are also known as retail credit accounts or store cards and are credit lines extended by certain retailers to allow consumers to purchase in-store or online with no upfront payment.

However, these cards’ negatives are often hidden behind sales tactics and misleading promotions that mask how much you’ll actually pay. The most common of these include interest-free periods or a certain amount of free credit on purchases over a specified amount.

These tactics hide the high interest rates these accounts attract (often around 30% ARP) and how they help incentivize impulsive, needless spending. The ease of opening these accounts contributes to their dangers, with unnecessary purchases quickly adding up and creating burgeoning interest payments that can take a long time to whittle down. 

Logbook Loans

Logbook loans in the UK underwent massive growth during the mid-2010s and are a popular form of loan. By putting your car up as collateral, these loans allow you to borrow against the value of your vehicle by temporarily signing ownership over to the loan provider.

These loans are incredibly popular among lower earners, and many providers do not conduct formal credit checks. However, this has led to some people, like those who play the best online slot machines beyond their means, taking out higher loans than they can afford.

Like the other forms of loans above, logbook loans also carry high interest rates, topping 400% ARP in most cases. Many providers of these loans have also been found to overvalue cars to extend inflated credit in hopes of higher interest, which can be dangerous and lead to spiralling debt. 

Alternative Loans

Although the abovementioned loans are among the most popular, they are not ideal for those looking to avoid the burden of long-term debt. Fortunately, better options that provide lower interest rates and more favourable terms do exist.

Personal Loans

Offered by credit unions and banks, personal loans can be taken out and almost entirely depend on your credit rating and current affordability—meaning the credit lines do not usually exceed your means. Personal loans often offer much more favourable interest rates, averaging around 6.1% ARP.

Overdraft

Overdraft facilities are short-term funds that can be accessed by adding additional accessible funds to your current account. These facilities, which require credit checks, offer low interest rates and often don’t accrue interest within the first month if the balance is paid off. 

Peer-to-Peer Loans

Peer-to-peer loans, offered through platforms that connect borrowers with lenders, have become increasingly popular. These platforms often provide competitive interest rates (if you have a good credit rating) and can help avoid the pitfalls associated with other types of loans.