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Introduction
As a lot of the content on this site relates to using controlled borrowing to resolve pending debt problems, we thought it might be helpful to our readers if we created a series of articles about debt and borrowing, covering both the benefits side of borrowing as well as the downsides and risks associated with borrowing.
We should stress that these articles represent our own thoughts on this subject and are intended to give the reader food for thought on the various aspects of debt, both good and bad, which will hopefully encourage anyone contemplating taking on debt to look carefully at their situation to ensure that what they intend is sensible and affordable. Where the consumer is experiencing the beginnings of rising debt or this has become locked into an unmanageable debt cycle, we very much hope our guides on debt and borrowing will prompt them to seek help from one of the many specialist groups and organisations that are available.
Budgeting is Essential
We are very aware in this day and age of internet buying and on-line bank accounts that many people find it very difficult to properly control their finances and this can often be part of the cause of borrowing becoming out of control.
In an effort to help with this, we have created a simple spreadsheet that will let you set out your income and expenditure monthly, over a two year period, to let you see clearly what you are really spending against your true income.
To learn more about this spreadsheet and request a copy, please see Part 8 of this series of guides.
Borrowing in Today’s World
Modern economies such as that of the United Kingdom, thrive on borrowed money. At government level, national spending budgets are set against the forecast income from the tax raising activities of HMRC and government planned borrowing. This is all supported by the growth and inflation controls set by the Bank of England. When the governments spending plans go out with its budget predictions, the government can look to the Bank of England and the UK’s high financial rating, to raise any shortfall.
How Corona has Compounded Borrowing?
We have now all experienced at first hand, a very good example of this during the current covid virus pandemic, where a very unprepared government has unexpectedly been forced to raise huge sums of money to fund its furloughing scheme, plus the massive additional cost of supporting locking down the whole country for much of 2020 and 2021.
Individual Borrowing
In a similar but very small way, this approach filters down to individuals and families who rely on borrowing to obtain the things that they desire now, rather than save to buy at a much later time. With Government generally encouraging people to spend to support the economy, many of us now live in an environment where we no longer save for that rainy day. Instead, we act a bit like our Government in that we spend our income as we get it, often finding that rising amounts of that income is going to repay our debt. This can cause a a tightening of our finances which will eventually threaten our way of life. However, unlike the Government, should something unforeseen happen that suddenly reduces our supporting income, an individual or family unit may not be able to continue to prop up their debt, which could place them in serious difficulty.
Government Borrowing
As the United Kingdom has never defaulted on a loan, it is perceived by other governments, pension fund managers and investment fund managers as a safe body to lend to. This enables the UK Government to borrow what it needs on some of the best lending terms available. On top of this, the UK Government has additional borrowing facilities open to it, that individuals have no access to.
Some of these are shown below:
- Gilts – Gilts, or gilt-edged securities, are fixed interest government secured savings products that are used to raise money to finance Government spending. People and organisations who purchase these products are effectively lending their money to the Government in return for a guaranteed return on their cash, which is usually better than what they would receive from their bank. As the government has never defaulted on its loans, gilts are considered to be low risk.
- Bonds – Government bonds are investment products that provide a fixed rate of return, known as a coupon, until their expiry date, at which time you will receive back all of your initial investment. These bonds can be traded within on the market, within the term which is often up to 30 years. During that time, their value may go up or down but will always return to the original purchase value at the end of the issue term.
As the government will often issue these bonds during periods of very low national interest rates, they can ensure that their debt remains predictable and controlled for many years ahead. - Quantitative Easing – This is a process that the Bank of England sometimes uses to control the UK money supply during times of crisis. It will purchase large quantities of government bonds, making sure that the Government has access to the funds it needs, on very good terms.
People tend to think that the Bank of England simply prints this money but in fact, they are controlling the money supply by releasing their funds.
Commercial borrowing
Very large companies can issue a type of bond called Corporate Bonds. These bonds are operated in a similar way to those of the Government but because individual companies have very different levels of financial security, the interest rates they have to offer will be much higher than that of the government. Those companies with poor credit ratings may have to pay quite high rates of interest, if they are to attract investors.
Smaller companies don’t have that type of facility so will fall into the more traditional methods of borrowing such as approaching their bank. This puts them on a similar borrowing footing to individuals and families but with their ability to borrow based on their trading accounts and profitability rather than personal income, as is the case with individuals and families.
Individual borrowing
As individuals, we don’t have access to the sophisticated borrowing facilities of Government or large companies and have to work within the more traditional methods, such as through personal loans, hire purchase arrangements or bank overdrafts.
Credit cards are now commonly used to complete purchases of sometimes quite large amounts. They tend to charge high interest rates and set minimum monthly repayments, however they can build up debt if not used carefully.
Large purchases, such as property, will usually be mortgaged through a bank or building society, often through a mixture of fixed interest rates and variable interest rates. However, as in all forms of borrowing, the terms that are offered to the borrower will always be dependant on the lenders perception of the risk associated with the loan not being repaid. The greater this perceived risk, the costlier will be the loan until the risk is such that the lender will refuse to lend.
