FOOL'S EYE VIEW
Pay Less For Your Loan

By Cliff D'Arcy
July 13, 2004

I'm going to start this article by removing my 'grumpy old man' hat. When I'm wearing it, I'm obliged to grumble and whine about the perils of getting into debt, and how paying interest instead of earning it can lead to lifelong impoverishment. However, I'm not going to trot out these arguments today, because I recognise that there are times when almost all of us have to borrow money.

Incidentally, in a BBC radio phone-in earlier this year, I had the pleasure of speaking to a 94-year-old caller who was proud to reveal that he'd never borrowed money in his entire life. He came close to borrowing a few quid about 75 years ago to buy a new cooker after getting married, but he opted to buy a second-hand stove instead. As it turned out, by staying free of the banks' clutches and being a determined saver and investor, he became rather well off, with a decent income and several properties to his name. Good for him!

Alas, for the rest of us mere mortals, borrowing money is a fact of life. We do it on a large scale when we buy our homes, and on a smaller scale to pay for other goods. For example, we spent at least £120 billion last year on our credit cards - and credit-card debt has increased from £10 billion to £55 billion over the last ten years. Eek!

Another major source of credit is the unsecured personal loan. These are most often used to pay for cars, holidays, home improvements and debt consolidation. We borrow tens of billions of pounds via personal loans every year, but how many of us shop around to get a bargain? Read the ten tips below if you'd like to become a master 'loan arranger'...

Tip One: Draw up a budget first

There's no point in test-driving an Aston Martin if your budget will only stretch to a second-hand Ford Cortina! Add up all your sources of monthly income and do the same for your monthly expenses. Don't forget to take account of bills that you pay quarterly (perhaps your BT bill) or annually (TV licence). Take your outgoings from your income to establish a figure for your monthly disposable income. For example, £150 a month roughly translates into a loan of £5,000 over three years.

Tip Two: Loyalty increases your interest bill

If you're one of those people who don't shop around for financial products but merely trot along to their local bank branch, you may as well burn a big pile of tenners. On a £5,000 loan over three years, your total interest bill could come to £500 or £1,500 - which would you prefer? Shopping around for a Best Buy could save you a grand, which could pay for a delightful city break or a week in the sun.

Tip Three: Say TAR, not APR!

All credit agreements in the UK must show the APR (Annual Percentage Rate). However, these are not as straightforward as they look and can be misleading. Also, many lenders advertise 'typical APRs', which you might not get unless your credit history is spotless.

It's much better to compare the TAR (Total Amount Repayable). As you'd expect, this reveals the total amount that you're expected to repay, including all monthly repayments, fees and charges. Therefore, the lower the TAR, the better the deal - it's as simple as that!

Tip Four: Give payment protection insurance the elbow!

Lenders 'strongly encourage' borrowers to buy payment protection insurance, which provides life cover for your balance and accident, sickness and unemployment insurance for your monthly repayments. In fact, they sell PPI so aggressively that it comes as a surprise to many borrowers that this is, in fact, optional cover!

The reasons that lenders are so keen to sell this cover is that is one of the most profitable financial products around. Insurers price it to provide a profit margin of at least 80%, most of which ends up as commission paid to lenders. Would you buy this product, knowing that it is five times as expensive as it needs to be, yet policies are riddled with exclusions and get-out clauses? Before you sign your loan agreement, make absolutely sure that the lender hasn't given you a 'protected' loan if you didn't want one!

Tip Five: Watch out for variable-rate loans

The vast majority of personal loans are arranged on fixed rates, which means that your interest rate and monthly repayments are fixed throughout the life of your loan. However, a few lenders do offer variable-rate loans, with which you could see your repayments rise or fall. Given that the Bank of England's base rate is on the rise, it's fairly likely that lenders will protect their profits by increasing the cost of variable-rate loans for existing customers.

Interestingly, although the base rate has risen by 1% since it hit a low of 3.5% in the second half of 2003, this seems to have had little effect on rates for personal loans. In fact, it's still possible to find a personal loan at around 6% APR, however, given that most banks' standard mortgage rates are higher than this (typically 6.5%), it remains to be seen how long these ultra-low loan offers will last. Perhaps you should buy now while stocks last!

Tip Six: Decide how long you want your loan to last

Generally speaking, the long the term of your loan (the period over which you repay it), the larger your interest bill, because you're being given more time to repay. So, if you can comfortably afford the repayments, why not repay your loan over a shorter term, say, three years instead of four? You'll be debt-free that much quicker.

Tip Seven: Save by shopping around

You'll find that most lenders will require you to pay by Direct Debit in order to have access to their best rates. Furthermore, the lowest interest rates are usually found from direct lenders who lend online or by telephone, not in your local High Street. That's because running a vast branch network is expensive, so it's fairly unusual to see the banking giants' products in the Best Buy tables.

Tip Eight: Go for a plain vanilla loan

Lenders have come up with all kinds of bells and whistles to attract borrowers, including repayment holidays, 'buy now, pay later' deals and 'free' additional benefits. In reality, all these gimmicks do is inflate the cost of your loan. In all honesty, you'd be much better off choosing the cheapest deal and ignoring all the frills.

Tip Nine: Watch out if you repay early

Around seven out of ten personal loans are paid off early so, if you think you may go down this route, find a loan that doesn't penalise you for doing so. You could pay a hefty fine for early settlement: up to two months' extra interest.

Tip Ten: Keep your eyes peeled!

Finally, watch out for things hidden away in the small print, such as arrangement fees, late payment charges and so on. If you don't understand what you're buying, do the common-sense thing and walk away. Otherwise, you could end up with a nasty debt burden to go with your shiny new motor!

More: Get a great deal in our Personal Loan centre.