Unsecured loans checklist
So you've made the decision to go for an unsecured loan, and you're evaluating a particular loan as a possible option for you. Here's a checklist of things to consider:
- How much interest will you pay over the course of the loan? Look at the TAR (total amount repayable). Obviously, the lower the better, but other factors may mean that you don't pick the absolute cheapest loan on offer. The TAR is the most important thing to consider when choosing a loan.
- Is the interest rate fixed or variable? The majority of personal loans still offer fixed rates. It's probably best to go for this option as then you can be certain about how much you will have to pay in future.
- Are there early repayment penalties? Seven out of 10 borrowers repay their loans early, yet they're often penalised by their lenders for doing so. Lenders are allowed to charge up to two months' interest as an early repayment penalty. If there's a possibility you will repay your loan early, look for a loan that won't sting you if you do – our loans search tool lets you filter your search to see loans that don't charge early repayment fees.
It's also worth checking to see if you can make lump sum overpayments during the course of your loan.
Unsurprisingly, flexibility costs money and you may end up paying a higher interest rate if you go for the flexible option, but if you think you may be able to repay early, then consider this option very seriously.
- Look at your monthly repayments – make sure that you can meet the monthly repayments. Be careful though. It's tempting to reduce the monthly repayments by increasing the period of the loan, but you'll end up paying a higher total interest bill as a result.
Secured loans checklist
- All of the items in the checklist for personal loans apply here. Once again, the TAR is the most important point. Some secured loans charge punitive rates – avoid these!
- Have you heard of the lender? Some of the lenders in this area are cowboys. It's best to only go with a lender that you have heard of and which has a decent reputation. If you've seen the lender advertising on daytime TV, that's probably a minus point.
- Are there any features with hidden costs? While this applies to both secured and unsecured loans, you'll want to be especially vigilant about it with secured loans, as there is the potential for costs to spiral with a larger loan or a longer term.
Be wary of... cashback loans
These sound like a great idea. When your loan comes to an end, you'll get some of your interest payments back – perhaps 25%.
However, there are normally some catches. For starters, you won't normally get the cashback if you pay off your debt early. The same applies if you're late with one of your payments.
And worst of all, you normally will only be offered a cashback deal if you also buy PPI… and that warrants a warning of its own!
The final word on cashback is to be cautions, and when you're evaluating possible loans, not to get too excited if there is a cashback offer.
Be wary of… PPI
PPI stands for Payment Protection Insurance and is a big money-making racket for the banks and other financial institutions. The Fool first highlighted the PPI scandal back in 2003 long before many other financial publications and websites.
The idea is this: you buy some PPI and then if you can't work due to accident, sickness or unemployment, the insurer will meet your loan repayments for you. The problem is that the cost is typically way too high and you may better off without PPI at all. Insurers make margins of 80 or 90p in the pound on PPI!
If you're keen to have the peace of mind that insurance offers, don't buy it from your lender. Instead search the market and find the best deal. Fool partner British Insurance offers competitive PPI products and we recommend them.
Be wary of… repayment holidays
Many loans offer the option of repayment holidays which allow you to take a short break from paying off your loan, typically for three months.
That sounds like a great idea, but on the downside, after your holiday is over you will have two choices: increase your repayments to pay off the loan within the original term or extend the loan and pay if off over a longer period. Either way, you'll be paying a higher total interest bill as a result of suspending your repayments.
So given that payment holidays make borrowing more expensive and can mean it'll take you longer to get out of debt, this feature isn't quite as beneficial as it appears at first.
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