FOOL'S EYE VIEW
How To Choose A Personal Loan

By Stuart Watson (TMFTiger)
June 13, 2001

Not many of us manage to go through life without taking out a loan at some point. Currently, about one-seventh of the UK population has a personal loan. As far as financial products go, they should be one of the least complicated. But the industry still makes its usual attempt to confuse what should be a relatively simple decision. Here are the factors you need to consider before signing on the dotted line.

Do You Really Need A Loan?

There are good loans, such as those to fund further studies, and there are bad loans, such as those to buy a brand new car when there is a model that is only one year old sitting in the driveway. Consider whether you really need to make the associated purchase or if you could save up some extra money instead. It's estimated that the majority of people who take a personal loan in order to consolidate their debts end up even further in the red.

Secured or Unsecured?

Personal loans will either be secured over some of the assets you own, usually your property, or unsecured. Secured basically means that the lender has a right to take the asset off you if you don't pay off the loan as you initially agreed. They may settle for a reduced payment plan instead. Consequently, the rates of interest on a secured loan will be usually be lower because the lender is taking on less risk.

But losing your house is not a pleasant thought is it? If you wish to get a lower rate of interest by going the secured route then an extension to your mortgage or a flexible mortgage may be more practical and cost effective.

Interest Rate

The lower the better. The better credit risk you are, the better deal you are likely to get. Some of the 'best buys' deals you see in the papers are only available to those with the best credit records.

But watch out for the small print. Many loans incur penalties if you pay them off early or if you vary your payments. As it happens many of us actually do choose to pay off our loans before their due date. As it is best to pay off your debts (especially high-interest ones) as quickly as possible there is very little reason to choose a loan that penalises you for doing so. If in doubt, don't be afraid to ask.

You also need to be wary of the various tricks companies can use when charging their interest. Some charge it all upfront. Others calculate the amounts due in different ways so although the headline interest rate may be the same the monthly payments may differ. Compare different loans using the APR (Annual Percentage Rate) and the monthly payments to help remove these distortions. Again don't be ashamed to admit if you're confused by all the figures or ask for further explanation.

Repayment Period

The shorter the better. Although it's tempting to choose a longer period as this will reduce the monthly payment this is often a false economy. In the long run this will cost you more in interest charges. Choose a repayment period that you can meet comfortably and if you find that you have additional spare cash along the way, use that to reduce your debt still further when you can.

Fees, Insurance and Payment Protection

Some lenders charge a fee for application. Most don't, so why bother with those that do? Other companies will offer lower rates if you take out their insurance products as well. However, this fact is often not made clear in their advertisements. In the main, financial products that are bundled together like this are usually more expensive than those bought separately, and best avoided.

As you fill out the application you may be asked if you want to take out payment protection as well. This is intended to ensure that your payments are covered in certain circumstances such as long-term illness. On the whole, these products are very expensive and you may already be covered for such eventualities elsewhere, through a works scheme for example.

You also have to read the small print on such schemes with a great deal of care, as many them exclude a lot of illnesses or other events that you might think you could make a valid claim under. If that wasn't bad enough the amounts due can be rolled up into the loan so that you end up paying additional interest on that amount as well. Considering that most people pay off their debts early, payment protection is usually an expensive waste of money.

Negotiate

Don't be afraid to negotiate. For example, your own bank may be encouraged to offer you a better deal if you happen to mention what sort of deal you have been offered elsewhere. They can only say no! You might also be able to get a special deal if you are a graduate or if you are looking for a loan to help you finance further studying or a professional qualification.

More: Get Out Of Debt