Great Deals For Borrowers!

By Cliff D'Arcy
May 30, 2006

Last Tuesday, I explained how to make the most of your plastic in How To Master Your Credit Cards, which showed you how to borrow at under 5% a year for life, pay no interest on your debts for a year or more, and earn cash as you spend.

This week, I'd like to show you how to get maximum value for money by choosing the perfect personal loan. Each year, around 6.5 million people take out a personal loan, making them one of the most widely held financial products in the UK (but well behind credit cards, of which there are 74 million!).

Alas, I'm willing to bet that nineteen out of twenty people who arrange a personal loan make some simple mistake which prevents them from finding the best deal. However, if you follow the dozen tips below, you can join the brilliant borrowers who beat the banks every time!

1. Is a loan the best thing for you?

If you're borrowing a few thousand pounds and expect to repay this debt over a few years, a low-rate personal loan might be right up your street. However, if you're borrowing smaller amounts over shorter periods, say, less than a year, then a 0% credit card or even an authorised overdraft may be a wiser bet.

2. Borrow as little as you can

Don't be deceived by those awful adverts which encourage you to "borrow a little extra to treat yourself". Remember: the more you borrow, the more interest you pay, so don't be fooled into spending even more of tomorrow's money today. Borrow only what you need and no more.

Also, try to arrange your loan over as short a timescale as possible, while keeping the monthly repayments affordable. Naturally, repaying a loan over three years will cost you more than repaying it over two, because your repayments are lower, so you pay off the debt more slowly and, therefore, pay a higher interest bill.

3. Beware of rolling up your debts

Another problem with those awful loan ads on daytime TV is that they urge you to "consolidate your debts into one easy, affordable monthly repayment". However, as I warned in The Dangers Of Consolidating Your Debts, five out of six borrowers who rolled up their debts into a single loan later went on to build up yet more debts to go with their loan!

What's more, most consolidation loans are arranged over long periods, in order to keep the monthly repayments down. Alas, the longer the term of your loan, the more you pay back, so this means an even bigger interest bill in the long run!

By the way, I believe that there's a loan ad with the following strapline: "Borrow enough to get out of debt". How crazy is that? You can't "clear your debts" by borrowing more; you need to get out of debt instead, perhaps by using the snowball technique.

4. Avoid borrowing against your home

If you have a peek inside a tabloid newspaper, you'll find umpteen pages of loan adverts. However, these are all secured loans, which means that they are secured against your home. Avoid these second mortgages if possible, because if you fail to keep up the repayments, you could lose the roof over your head, as I warned in Lessons From The Last Housing Crash.

5. Ignore the APR, but check the TAR!

By law, all loan agreements and lending documentation must include the annual percentage rate (APR), which is a standardised figure for measuring the interest rate on borrowing. However, because APRs can be manipulated in at least three ways, I don't rely on them when comparing loans. Instead, I check the total amount repayable (TAR), which includes the loan advance and all charges for credit. In other words, the TAR shows what you'd repay, right down to the last penny. Hurrah for the TAR!

6. Choose a fixed or variable rate

The vast majority of personal loans charge an interest rate which is fixed throughout the life of the loan. Hence, your monthly repayments aren't affected by the future direction of interest rates. However, a few lenders, such as Cahoot, offer both fixed- and variable-rate loans but, given that interest rates are likely to go up in order to counter rising inflation, I'd opt for the security of a fixed-rate deal.

7. Are you a 'typical' customer?

Four in five lenders (80%) now use risk-based pricing, which means that the interest rate which you're offered will depend on your personal circumstances, credit history and ability to repay. In theory, two-thirds of borrowers (67%) should receive the advertised 'typical APR' but, in practice, this rule is often broken.

Hence, if you have a less-than-spotless credit history, or you don't fit a lender's ideal customer profile, you could be offered a rate much higher than the headline APR, or have your application rejected outright. If you don't think that you're an A1 customer, then shop around for a loan which charges the same rate to all borrowers (Nationwide BS is usually a Best Buy here).

8. Loyalty is for dogs, so shop around!

In Is Your Loyalty Being Rewarded?, I concluded that the loyalty, bonus and reward schemes offered by lenders to their existing customers were not worth having. Indeed, disloyalty pays big dividends! Therefore, when you're looking for a loan, please steer clear of your bank until you've first found at least three excellent quotes. You can then give your bank the opportunity to beat your best deal -- or lose your custom if it can't or won't!

9. Shop around online to find the lowest rates

Don't waste your shoe leather by tramping from branch to branch trying to find the lowest loan rates. This is a complete waste of time, because you'll only find the high-street banks in the "Don't Buy" tables, not the Best Buy tables!

To make life easy for you, we've gathered together many of the Best Buy loans in the Fool's Personal Loan centre, plus our search wizard (powered by independent financial researcher Moneyfacts) searches the entire market on your behalf.

10. Don't buy payment protection insurance (PPI) from your lender

Roughly half of all personal loans are sold with payment protection insurance included, which meets a borrower's monthly repayments if s/he is unable to work due to accident, sickness or unemployment, and pays off the debt if the borrower dies.

Unfortunately, PPI is perhaps Britain's biggest financial rip-off, because it's vastly overpriced. Typically, adding PPI will increase the cost of an unprotected loan by around 15%, with some lenders charging more than 25% for this cover.

NEVER buy PPI from a lender; instead, if you must have the peace of mind which PPI offers, then shop around for a stand-alone PPI policy from an independent provider such as British Insurance, Paymentcare and Payprotect.

11. Beware of delivery charges

In order to boost their profits, some lenders charge a fee for sending a cheque to you by courier or paying your loan into your bank by telegraphic transfer. For example, Northern Rock charges £35 for its same-day express service. Unless you need the money in a hurry, don't pay these charges, as they bump up the cost of your loan yet further.

12. Watch out for early settlement penalties

Around seven in ten personal loans (70%) are paid off early, often because borrowers are replacing an existing loan with a new loan. The law allows lenders to charge up to two months' extra interest if you settle your loan early, but some lenders don't charge any penalties for early repayment. If you're likely to repay your loan early, then be sure to choose a lender which doesn't fine you for doing so.

Congratulations, you're now a brainier borrower!

More: Compare personal loans at the Fool | Don't forget that you can compare credit cards, too!