Laura Starkey finds out whether a loan or a credit card will offer her the cheapest deal.
In times like these, borrowing to buy the things you need is far from ideal.
Interest rates on all types of credit have risen since last year, which means going into debt to fund a purchase is more expensive.
But what if you have no choice but to borrow? I was put in this position recently, when I was preparing to move house and needed extra money to help smooth the process and buy furniture.
Having recently finished a postgraduate degree, I don’t have savings -- and so needed to consider what sort of borrowing would offer me the best deal.
I looked at how much it would cost to get hold of the £3,000 my partner and I needed, comparing credit cards and personal loans.
Here are my findings…
Personal loans are pricey
While the structured way in which I’d be required to repay a personal loan appealed to me, the interest rates I’d be charged certainly did not.
According to Fool partner Moneyfacts, the price of personal loans is now at a seven year high, and the average interest rate charged on a loan of £5,000 has risen to 11%.
These are the best typical rates I could find on a £3,000 loan over two years, from two market-leading personal loan providers.
As you can see, they’re far from friendly.
Borrowing a relatively small amount from a bank is actually more costly than borrowing a bigger one. If I applied to borrow £10,000 instead of £3,000, the typical rates on offer from Moneyback Bank and Alliance & Leicester would shrink to 7.6% and 7.7% respectively -- far more competitive.
I wasn’t impressed by the rates available to me for a £3,000 loan, and definitely wasn’t prepared to borrow more than I needed to get them reduced.
So, what were the alternatives?
Low APR is an option
As my Foolish colleague Neil Faulker recently reported, credit cards with genuinely low APRs are rare beasts.
However, there are a few with APRs of less than 10% roaming through the market right now -- which would offer me the opportunity to borrow my £3,000 for less than either of the loans I looked at.
Both the Barclaycard Simplicity and the Capital One Low Rate card offer lower interest rates than the loans.
Getting hold of £3,000 would cost me £125.60 less if I decided to borrow it from Barclaycard instead of Moneyback Bank.
This might not be a fortune -- but in my opinion it’s an effortless, simple saving to make. And that’s my favourite kind!
0% is nicest
Of course, opting for a credit card with a 0% on new purchases offer could cut the cost of my borrowing down to zero.
However, 0% deals don’t last forever. In fact, they rarely last more than a few months.
This presents a problem, as people who borrow £3,000 (myself included) generally need longer than this to pay off their debt.
And when promotional 0% periods end, most credit card providers hike up the interest customers pay on purchases to their standard rate. This might mean whatever balance is left on your credit card becomes very expensive to repay.
So could interest charges eat into the savings you made by choosing a 0% deal in the first place? I decided to work it out, looking at two cards which currently offer great 0% deals on new purchases.
While both cards’ 0% periods end before the two year time limit I’ve set for paying off my £3,000 debt, they are still the best ways to borrow.
Here’s why…
• Assuming that an applicant got a Capital One Platinum Card in September, they’d enjoy 14 months of interest-free borrowing before their promotional 0% deal ended.
• By that time, having made monthly repayments of £135, they’d have cleared £1,900 of the balance.
• The remaining £1,100 would take a further nine months to repay at 14.9% APR -- and would cost a customer £63 in interest during that time.
In the end, borrowing £3,000 on this card isn’t completely free. But it is still £270 cheaper than the cheapest personal loan I could find, and £145 cheaper than borrowing the same amount on a low APR credit card.
Even the Halifax card, which proves more expensive as its 0% period is shorter, remains the second-cheapest option for borrowing £3,000. It costs £150 -- £183 less than a loan.
For me, the Capital One card was the clear winner in this race. What’s more, as I’m fervently Foolish, I intend to avoid paying even £63 for my borrowing.
When my 0% purchases deal ends, I’ll transfer any balance I’m yet to pay off to a 0% balance transfer credit card or a lifetime balance transfer card.
This will mean my debt is even cheaper -- or absolutely free!
Things to think about
There are always a few ‘buts’ with financial products -- including the ones mentioned in this article.
Since the credit crunch, it’s more difficult to get accepted for credit cards and loans. This means that popular products such as credit cards with 0% deals can be particularly hard to come by -- so consider your credit history before applying.
It’s also worth remembering that most APRs on credit cards and loans are ‘typical’. This means around two thirds of successful applicants will be awarded these interest rates -- but the remaining third will probably get a worse deal.
Also, I’d recommend leaving a new credit card in a locked drawer, cutting it up or even putting it in the freezer once it's fulfilled its purpose. This will prevent you spending more on it than you intended. (Yes, I really have put credit cards in lunchboxes full of water and frozen them. It works!)
Finally, don’t allow the flexibility of credit card repayments to fox you. Avoid letting your debt persist by setting up a monthly direct debit for the regular amount you want to repay -- and sticking to it!
More: How To Borrow £5,000 | My Top Three Personal Loans | The Cheapest Way To Borrow A Grand
