FOOL'S EYE VIEW
Beware The Hidden Costs Of Borrowing

By Cliff D'Arcy
June 3, 2003

Some companies seem to excel at concealing information from consumers. Not just trivial stuff buried in the small print, but pretty damn important information that, as paying customers, we expect to be told up front. Banks, insurance and investment companies and so on employ cunning marketing people whose job is to come up with messages and sales pitches designed to highlight the best features and downplay (or fail to mention) the worst features of financial products.

Of course, the Financial Services Authority (FSA) is there to protect us from misleading advertising. Nevertheless, it admits that it cannot police every offer from every firm (as it has to supervise around 10,000 firms and 158,000 individuals).

What's more, most products that contain no investment element are not monitored by the FSA. These include many protection (insurance) policies, lending products (cards, loans and mortgages) and savings accounts. Of course, other regulators and legislation govern these products, but voluntary regulation will never be as forceful as the statutory requirements.

So, how do we spot the rogues and the techniques they use to lighten our wallets and purses? Obviously, there are no hard-and-fast rules, but I'll give you some idea of what to watch out for, using the personal loan market as an example.

The figures below (taken from the May edition of Moneyfacts) are based on a loan of £5,000 repaid over three years.

Decline payment protection insurance and other extras

I guarantee that you'll be offered payment protection insurance (PPI) at every point during the lending process. PPI policies are hugely over-priced and packed with small print and get-out clauses. PPI is usually sold "assumptively" - the lender will automatically add the insurance premium to your loan (often without your awareness or prior permission).

What's more, PPI usually massively increases the cost of your loan. For example, Birmingham Midshires charges £165.20 a month for an unprotected loan, or £203.86 including PPI. So, PPI increases your monthly repayments by a staggering 23%. Over the three years of this loan, you're paying almost £1,400 to protect a loan of just £5,000 - what a complete rip-off!

So, unless you think you're going to be off work sick or unemployed for at least one month in three, always refuse to buy PPI. Despite working in the PPI industry for over ten years, I've never bought a policy and never will.

Also, watch out for other add-ons or gimmicks the lender may offer you, such as personal accident insurance and so on. Remember, your goal is to borrow as cheaply as possible, so ignore all the bells and whistles and go for the lowest overall cost (see below).

Don't put up with hidden fees and charges

Some lenders add sneaky "arrangement" or "documentation" fees to their loans. Typically, these increase the cost by between £50 and £100, although some lenders charge 1% or more of the amount you're borrowing. The vast majority of lenders don't charge these tricky fees - don't borrow from those that do.

Always check the bottom-line cost

The easiest way to find the cheapest deal is to look at the "total amount repayable (TAR)". This tots up all the monthly repayments, fees, etc. to give you the final figure you're expected to pay. The lower the TAR, the cheaper the loan - it's as simple as that.

Compare the TAR of our protected loan from Birmingham Midshires (203.86 x 36 = £7,339) with an unprotected loan from Sainsbury's Bank (156.12 x 36 = £5,620). Sainsbury's Bank is almost £48 a month cheaper, producing a mammoth saving of £1,718 over three years!

So, compare TARs - you know it makes sense.

Beware of pricey application and payment methods

Lenders typically reserve their best rates for online and telephone applications, which cost them far less to process than face-to-face branch visits. If you can, apply online to a direct lender, whose interest rates are often under 7% APR.

Also, you'll save through paying by direct debit, as this is the cheapest way for lenders to collect your repayments. Some lenders will only lend to those willing to pay by direct debit; others charge extra for payment by standing order, cheque or payment book.

Additionally, watch out for charges for having a cheque delivered to you by courier; some lenders charge hefty fees for this service. Have the money paid directly into your bank account instead - it's the quickest way for you to get hold of your loan.

Loyal customers often get poor deals

Never, ever go into your friendly local branch, sit down and buy a loan without shopping around first. Otherwise, you may as well wear a "Please take me to the cleaners" sign!

High Street branches and staff are expensive to maintain, so many of the worst financial deals lurk within their premises. If you must be loyal, find the best deal you can and then challenge your bank to match it. If it says no, you can borrow elsewhere with a clear conscience.

Repayment holidays bump up the cost

Several lenders give you a repayment holiday at the start of your loan, usually a break of up to three months before your monthly repayments begin. Others allow you to take repayment holidays by deferring one repayment each year.

The problem is that interest builds up faster when you're not paying off your loan, so the lenders account for this flexibility through higher interest rates. Avoid this by going for the loan with the lowest TAR.

Beware of variable and "typical" interest rates

Competition is fierce for personal loans and certain lenders have responded by getting crafty. Instead of selling loans with fixed interest rates, they offer tailored rates based on your credit rating. One lender feels this misleads borrowers, as many end up paying far more than the advertised "typical" rate.

Our advice is stick to loans with fixed rates, as you know exactly how much you'll be paying throughout the life of your loan. Besides, do you really expect lenders to cut interest rates on existing variable-rate loans when the base rate falls?

Check redemption (early repayment) penalties

Although some lenders don't charge any penalties for early settlement of loans, the norm is to charge two months' extra interest using the complicated and unfair "Rule of 78". As the majority of loans are settled early, take this into account when choosing your lender.

Finally, remember the golden rules: shop around - go for your best deal, not your first deal - don't buy anything you don't understand!

More: Check out the bargains in the Fool's Personal Loan Centre | Personal Loans Don't Come Much Cheaper | Top Ten Loan Tips