AS THE Christmas spending spree gathers pace, there is a danger thousands of British households will be persuaded to spend more than they can really afford by some of the most attractive personal loan rates in living memory.
Fierce competition among banks, building societies, and credit card providers is ensuring that consumers borrowing more than £5,000 appear to have a wide choice of suppliers charging barely 6%. But the headline interest rate figure (APR) may be only a vague guide to the total amount borrowers eventually have to repay. 'Consumers are led to believe the cheapest loan is the one with the lowest APR,' said Richard Brown, chief executive of online financial comparison site Moneynet.co.uk. 'But loan packages do not always do what it says on the tin.'
Though APRs reflect the cost of credit, they ignore the cost of other add-ons such as payment protection insurance (PPI) and early repayment penalties - which invariably generate fat profits for many providers. PPI is sold with the promise of protecting repayments on loans, mortgages, and credit card debts. But PPI attached to personal loans - bought by 65% of borrowers - arouses the fiercest criticism.
A Credit Suisse report in September admitted: 'We think banks will find it difficult to defend the accusation that PPI is expensive. The average PPI policy on a personal loan generates income in year one equivalent to about 6% of the loan.'
Credit Suisse believes consumers spend more than £5bn a year on PPI - half of that to cover unsecured loans, 30% credit cards and probably less than 20% covers mortgages. But the low claims rate means profits exceed those from any other form of insurance, including household and motor.
Says Richard Brown at Moneynet: 'Providers advertise a competitive rate to attract customers. Once the applicant is convinced they have found a great deal, the commission-hungry provider makes every attempt to sell them payment protection insurance, thus increasing their margin via the back door.
' Moneynet.co.uk compares two loans of £7,000 over five years: the RAC at 6.5% charges £137.93 per month, while Nationwide at 6.7% comes in at £136.97. Add on the cost of PPI, and RAC's monthly repayment leaps to £189.24 - against £158.46 at Nationwide.
Another online comparison service, uSwitch.com, warns many APRs are effectively doubled by the addition of PPI: on a £10,000 loan over five years, for instance, Marks & Spencers' personal loan costs 6.2% without PPI, and 15.8% when it is added on. PPI sends the true cost of a Barclays Barclayloan soaring from 9.9% to 19.7%, and NatWest's personal loan up from 7.4% to 18.7%.
The Government's City watchdog, the Financial Services Authority (FSA) is urging providers to improve sales practices by early-2006. On credit cards, 40% of consumers pay for PPI, and 55% take it on storecards. Though the FSA is broadly happy with PPI sold to protect mortgage repayments, it believes PPI sold with credit must be drastically improved. Its 'mystery shopper' exercise found that around half of firms providing it fail to take reasonable steps to ensure customers do not buy policies on which they have little hope of making successful claims.
For Simon Burgess, managing director of Braintree, Essex-based British Insurance, FSA criticism vindicates his long campaign: as an independent broker, he sells PPI for about a third of prices charged by major providers. On a £7,500 loan over five years with a monthly repayment of just over £147, Burgess's recent survey uncovered additional PPI charges ranging from £21.03 at Nationwide and £21.06 at Abbey - up to £59.85 at Bank of Scotland. PPI policies from Burgess's brokerage, giving similar cover, cost £11.05.
Over five years this gulf produces an average saving of £1,450. Says Burgess: 'The main abuse of PPI premiums is on personal loans, although there is a massive rip-off too on protection sold on credit card debts. Less than 1% of premiums paid are effectively returned to claimants, while most of the money goes direct into retailers' pockets.
‘Even consumers who realise they have a choice of PPI providers have little chance of avoiding uncompetitive deals. Banks use high-pressure sales techniques to tell customers that if they don't take the loan protection, they won't get the loan - though better policies are available elsewhere for a tenth of the cost.'
At Paymentcare, another independent broker offering PPI at a fraction of rates charged by High Street giants, managing director Shane Craig says: 'One of the biggest scandals of PPI is that many people who buy it have very little hope of ever making a successful claim; for example unemployment cover for the self-employed is usually no benefit whatever.'
To break the monopoly of card companies, Paymentcare offers a stand-alone LASU policy (Life, Accident, Sickness and Unemployment) to protect monthly repayments on card balances for cardholders unable to make payments because of being unable to work.
Says Shane Craig: 'Credit card firms con customers in two main ways with card protection insurance - often by offering the first month's cover free to get them hooked, and then by playing on an average price point of only 79p per £100 of outstanding balance.'
Paymentcare claims its cover is cheapest on the market - at 0.65p per £100 of outstanding balance, it allows borrowers to cover outstanding balances on as many cards as they wish, from £1,000 to £5,000. So, when you take a loan, or run up a credit card debt, shop around for quotes before you insure repayments.
Take the lender's package and you are probably wasting money.