Before you look for a personal loan, you need to know how to compare different products. Here's how one former banker does it.
Before I became a financial writer, I spent fifteen years working in insurance and banking. Naturally, over such a long period, I managed to learn a trick or two and I learnt a great deal about credit cards, mortgages and personal loans.
I also picked up a few techniques on how to beat the system and recognise good and bad products when I saw them. For example, I discovered a really simple technique to compare personal loans - one which doesn't involve looking at annual percentage rates (APRs). There are several reasons why I choose to ignore APRs when sizing up loans:
APRs can be manipulated
Most personal loans give borrowers one month before they make their first repayment. However, some lenders offer applicants a longer initial "repayment holiday", typically, three months. Although this extra two-month breather may be attractive, it pushes up your overall interest bill, because of the delay in commencing repayments. However, a repayment holiday artificially reduces the APR, making a loan with an extended initial break look cheaper, when the reverse is true.
Typical APRs don't tell the whole story
Many lenders use "rating for risk", which means that the interest rate that you pay depends on a number of individual factors, such as your income, previous credit history and credit score. This means that customers seen to be the best credit risks get the lowest rates, while people with borderline credit scores or a spotted credit history are offered higher rates.
However, lenders advertising "typical" APRs must offer this rate to at least two-thirds (67%) of successful borrowers. Needless to say, lenders manipulate this requirement by rejecting a large number of applicants in order to reach their quotas. I know of one major lender which "cherry picks" the best customers by turning down seven out of ten applicants. In other words, only a fifth (20%) of applicants gets its typical rate, but it still meets the two-thirds rule. Sneaky, huh?
Payment protection insurance (PPI) doesn't affect the APR
PPI is optional insurance which covers your loan repayments if you can't work because of accident, sickness or unemployment, and pays off your balance if you die. However, lenders give this cover the "hard sell", and customer-service advisers are given stiff targets to meet for the sales of PPI. Hence, up to seven out of ten borrowers are coerced into buying this rip-off cover, which has led the financial regulator to warn about mis-selling practices in this field.
Many borrowers are sold PPI "assumptively" and, because the premium for this overpriced protection doesn't affect the APR, many customers don't notice that they have it. The bad news is that is can be amazingly expensive. For instance, for a loan of £5,000 over three years, Marks & Spencer money charges £160.95 a month (9.2% APR) for an unprotected loan. However, the same loan with PPI costs £186.95 a month (9.2% APR), which is £26 a month more. Thus, although a protected loan will cost you an extra £936 over three years, the APR remains the same.
How I compare loans
When I weigh up personal loans, I ignore APRs, PPI and all the other guff and look at one single figure: the total amount repayable (TAR). For example, in the above example, the TAR for an unprotected loan is 36 x £160.95, which is £5,794.20. For a protected loan, the TAR is 36 x £186.95, which comes to £6,730.20.
In summary: over the years, I've learnt to ignore APRs and only use TARs as my trusty yardstick to compare all types of loans. If you do the same, no lender can pull the wool over your eyes!
More: Don't look for a loan without checking out the Best Buys in our Personal Loans centre!
