HOW BORROWING CAN HELP YOU INCREASE YOUR WEALTH

12 Use Your Credit Card to Ease Your Cash Flow – Not as an Expensive Loan

A credit card is a useful means of borrowing short-term, as long as you make it work for you. Properly used, it can be a bonus source of interest-free money. If you pay off the balance in full by the due date, you pay no interest.

But wrongly used, a credit card is a disaster. You may end up paying crippling rates of interest of around 24 to 33 per cent or even higher. And since many issuers now charge interest from the transaction date rather than the statement date on uncleared balances your "loan" has got more expensive still.

Many issuers also charge an annual fee, usually in the £8 to £20 range. But some issuers provide their cards free, and most will rebate the fee if you spend above a certain amount on the card each year.

If your bank balance is low, use your credit card whenever possible instead of cheques – as long as you can pay off the balance when it's due. And, to maximise your "free" credit period, you can juggle with two or more cards with different payment dates. As soon as you receive a statement, switch to the card it relates to. With just two cards, you can expect at least 40 days' credit on every purchase you make.

Conclusion: While you've plenty of choice when it comes to credit cards, few are now free to use – even if you pay your monthly bill in full. But there are exceptions, so shop around. And, if you're a regular credit card user, don't waste the opportunities they offer to make the most of perks, or even to give to charity.

14 Don't Throw Money Away on a Loan You Don't Need

There are plenty of people around eager to lend you money. As a rule, the easier it is to borrow and the less security you have to offer, the more expensive the loan.

First, consider whether you really need to borrow. If you have £5,000 in the building society earning, say, 5 per cent after tax, it doesn't make sense to borrow £5,000 to buy a car at 15 or 20 per cent or even more. Even at the comparatively low rate of 15 per cent, borrowing the money will cost you an extra £500 a year in interest.

Perhaps you see that £5,000 as your "emergency fund". But remember, if you do need money urgently, you can always use your credit card – either for purchases or as a source of cash. Or you can ask your bank for a loan if the need arises. In the meantime, you'll be making substantial savings by not paying high rates of interest unless – or until – you really need to.

Conclusion: If you borrow to pay for a car or a holiday, you're buying a wasting asset – one which isn't going to produce an income for you. This kind of borrowing is best avoided. If you borrow to invest, it may be a different matter, as you'll see later.

If you already have a loan, it may make sense to use some of your savings to reduce it or clear it altogether, though watch out for penalty clauses for early settlement. This way you'll be making the best use of your resources.

With most issuers you don't always need to be an established customer to qualify for a gold or platinum card. You are only likely to qualify for a gold card if your annual income is at least £20,000 or £25,000 for a platinum card.

Conclusion: If you have outstanding credit or store card debts, consider borrowing from your bank to pay them off. You can expect substantial savings on large sums.

If you're thinking of borrowing to finance a purchase, avoid credit sale or hire purchase as you'll usually be charged a high rate of interest. Remember, if you pay cash, you'll often be given a discount on the purchase price.

The reason is simple. A lot of money is "dead" money a lot of the time. Let's assume you have a typical £80,000 mortgage from a bank or building society with which you also hold your current account. Each month you pay the lender a lot of interest on the loan and a little bit of capital by taking money out of your current account. Unless you are unusual, the cash you have in your current account will be earning you little – if any – interest.

So you are paying your lender interest on the full amount outstanding on your mortgage each month – on which there has been no tax relief since April 2000 – and receiving a much lower rate of interest, if any at all, on which you pay tax.

But your bank account – again, unless you are unusual – will normally start off each month with quite a lot of money in it, and as the month goes on the balance gets less and less until boosted again next pay-day.

You could be a lot richer if you could earn as much interest on the money in your account at the beginning of the month as you pay your building society. And if you could do it tax free – so much the better.

There is a way this can be done – and quite legally, too. It's called a flexible mortgage. It works like this.

Your mortgage account and your banking account are merged. When your salary gets paid in, the whole of the balance after your start-of-the-month standing orders reduces your mortgage loan – and the interest you are being charged. As the month goes on, the mortgage creeps up again as you spend your way through the salary, but not paying interest to your lender has had the effect of earning you that interest – tax free.

Conclusion: Flexible mortgages of this type can save you literally thousands of pounds. An average 25 year £80,000 loan will actually cost over £200,000. A flexible mortgage can be used not only to save interest, but also to repay more capital early, reducing your overall payments.

But merged account flexible mortgages have their dangers. Just as you may easily reduce how much you owe the lender, so will you find lenders keen to let you increase the amount you owe if house prices have gone up since you bought. The temptation is to use flexible mortgages as an instant source of money – and that way may lie trouble.

17 Review Your Mortgage Arrangements

If you've got a mortgage, don't sit back and assume you're stuck with it until you move house or pay it off. There may be savings you can make now.

On larger mortgages, say £200,000 or over, you may find you're offered a reduction in the nominal interest rate of about 0.5 per cent. You don't necessarily need to have an existing account with a potential lender, though some banks may expect you to keep your main account with them. And you can often save an amount equal to the legal fees for the new mortgage in just a few months of lower repayments. There may also be an extra incentive reduction in the interest rate for up to the first year.

If your earnings are in a foreign currency, you may be able to make considerable savings by taking out a mortgage in that currency, rather than in sterling. This happens when interest rates on foreign currencies are lower than rates in the UK. Foreign currency mortgages are risky, though, if you're paid in sterling. Any fall in sterling against the currency of your mortgage or rise in the interest rate you pay could dramatically increase not only your monthly interest payments but also the size of your outstanding debt. Conversely, of course, if sterling appreciates against the currency of your mortgage, you gain.

Although the interest rate you pay on your mortgage is important it's not the only factor. What also counts is the proportion of each repayment that is interest. With a repayment mortgage, part of what you pay each month reduces the level of outstanding debt, so in the early years of the loan most of the monthly payment is interest and only a little of it is capital repayment; in the last year of the mortgage, nearly all of it is a capital repayment. With this type of loan, as each year goes by, you see your debt shrink. The disadvantage is that the money you repay to the lender ceases to work for you.

The other type of mortgage is an interest-only mortgage, where you only pay interest each month to the lender, and make separate arrangements for paying off the capital debt at the end of the life of the loan. This used to be done with an endowment life assurance policy, but now you can also borrow against the future value of your pension scheme, or regular savings plans tied to unit trusts and investment trusts, often wrapped up in a tax-saving envelope such as an Individual Savings Account.

The advantage of these schemes is that the money you would otherwise have repaid to the lender works for you over the whole life of the loan. You thus get the advantage of compounding profits. There are tax advantages to several of the interest-only packages: the best is the loan against a pension fund, where all your contributions are fully tax deductible, and all interest and capital gains in the fund are tax free as well.

The main disadvantage of these schemes is that you won't have paid off any of the loan when you move, and a new lender might insist you take out new plans to support any additional borrowings.

Firstly, if you use the loan for a purpose which would normally attract tax relief, you will not be charged tax on the benefit.

Secondly, you may have an interest-free or cheap loan of up to £5,000 without paying any tax on the benefit.

If you have a bigger loan, the Inland Revenue will tax you on the benefit. They work this out by applying their own notional rate of interest – the "official" rate – which is usually around the current mortgage rate. They then tax you on the difference between that and what – if anything – you actually pay.

If your employer provides you with a cheap or interest-free loan to buy a house, this does not count towards the £5,000 exemption limit. But you will be taxed on the difference between what you actually pay and what you would have paid using the taxman's "official" rate, minus the tax relief you would have got on a loan at the "official" interest rate.

19 Use Gearing to Multiply Profits

You've looked at some of the ways you can gain by borrowing – interest-free credit on credit cards and interest- and tax-free loans from your employer, for example. You've also seen that borrowing to buy a car or some other non-productive purchase is not a good use of your resources. A car depreciates in value – so you lose money twice over if you pay interest on a loan too.

But borrowing money to invest is different, assuming your investments grow faster than the interest you pay on the loan. This is what you expect to happen, at least over the long term, when you borrow money to buy your house. By the time you've repaid the mortgage, the house is likely to be worth substantially more than the amount you invested in it – your original deposit, the mortgage and the interest you paid, even after you've taken inflation into account.

This use of borrowed money to increase the return on your investments is known as gearing, or sometimes as leverage. Since you can't usually guarantee the return you'll get on your investments, there's more risk as well as the prospect of greater reward. The combination of increased potential for both risk and reward is a fundamental investing principle.

Conclusion: If you borrow sensibly, searching out the best deals on offer and avoiding over-commitment particularly at high rates of interest, you can enhance your returns. Don't be over-optimistic about the gains you're likely to make and be prepared to choose a relatively long-term investment. Investment success usually comes from making steady gains over a period of time rather than one "big hit".

Click here to Register for a FREE 30 days Trial