Many people will be tempted to take out a personal loan to meet the cost of Christmas, but, warns Emma Lunn don't just look at the headline rate of interest before taking the plunge
Now that the Christmas lights have been switched on in London's Regent Street, thousands of people wiff be scratching their heads wondering how on earth they are going to pay for all those presents, food and drink come December. The chances are that thousands of people will overstretch themselves this Christmas last year half of the British population spent more than their monthly pay packet over the festive season. It is also likely that many people will take out a personal loan to help tide them over this period "Christmas is an expensive time of year and for most people borrowing is a fact of life," says Richard Duvall, the chief executive of Zopa, the online lending and borrowing exchange.
"The issue at this time of year is to be clever in how you borrow. Cards are easy but expensive and, given that most people spread the cost of repaying Christmas over a number of months, a low-cost loan without early repayment penalties fits the bill better than expensive short-term credit with lots of nasty catches."
Gone are the days when you simply popped down to your local bank or building society for a personal loan. They are still an option, of course, but there is a plethora of loan companies on the market, and you can log on to the internet or call any of a number of financial firms to arrange a deal over the phone. There are some attractive low headline rates around the 5-5 per cent mark, but it is hot just a good interest rate borrowers need to look for: early repayment penalties and costs for payment protection insurance (PPI) need to be taken into account too before taking the plunge. PPI has been making the headlines recently - but for all the wrong reasons.
A PPI policy should make repayments for you in the event of accident, sickness or unemployment. But the price of cover can vary dramatically and it is sometimes sold to people who could never make a valid claim - the self-employed, for example. Morgan Stanley, the investment bank, estimates that as much as a fifth of banks' profits comes from the sale of these controversial policies, which are sold alongside credit cards and personal loans. The cost of this insurance can push the headline APR (annual percentage rate) on a typical £10,000 loan up from 7-9 per cent to 23-6 per cent, according to the bank.
Just 10 days ago the Financial Services Authority published some damning research following a mystery shop of 45 lenders. It has warned of a possible mis-selling scandal following its investigation and said that a number of firms face possible enforcement action for poor selling practices. The FSA found that around half of the companies surveyed failed to take reasonable steps to ensure that customers did not buy policies on which they could not daim or which provided only very limited cover.
It also found that advice given by staff about the suitability of a PPI was inadequate and that financial incentives could encourage staff to mis-sell the insurance. "Compliance standards are generally weak," says Clive Briault, the FSA's managing director for retail markets. "This poses a serious risk to consumers because of the poor disclosure of product and price details, the possibility that consumers may not be
eligible to daim against their policies and the fact that consumers may not be aware that they may receive little money back if they cancel these policies early." People should take time to consider whether they really need the protection of PPI.
Many lenders add the insurance premium to the loan at the outset If this is the case, you will pay interest on it until the loan is repaid If you do need PPI, you will almost certainly be better off opting for cover that allows you simply to pay a monthly premium. Some lenders charge lower interest rates but increase the insurance cost which means a loan looks cheap but the overall cost is higher.
Andy Smith of uSwitch, the price comparison website, says the interest rate becomes irrelevant as APRs do not take PPI payments into account "Instead customers should compare loans by looking at what they are paying back each month," he says. "It can work out better to take out PPI from a specialist provider instead of your loan provider, as we've found that lenders sometimes charge up to 340 per cent more."
Research from Moneyfacts,the financial analyst shows that using a specialist PPI provider can save you more than £700 over a three-year period for a £5,000 loan. For example, HSBC would charge £1,020-24 (£28-34 a month) for PPI cover on a loan of £5,000, while Paymentcare would cover the same monthly repayments for a total of just £308-88, which works out at £8-58 a month. The good news for borrowers is that earlier this year the Department of Trade and Industry changed the rules, forcing lenders to provide dear information upfront to enable consumers to compare personal loans more easily and shop around It also introduced rules which mean borrowers paying back a loan early get a fairer deal.
The new rules mean that before customers sign a contract lenders have to set out the main factors of the loan, such as the total amount borrowed the total amount repayable, amount and frequency of repayments, annual percentage rate, the cost of any default penalties and examples of early settlement or redemption charges.
Be aware that early redemption penalties may apply if you pay off the loan before the term is up. Tney are normally one or two months' interest charges and sometimes more if you have PPI. "Early redemption charges are no longer as horrendous as they used to be," says Smith. "But if you think you might be paying back the loan early it's worth looking for low early redemption penalties as well as a good headline rate." It is worth scouring the best buy tables for the lowest APR, but remember that these rates may not be offered to all applicants. New rules say the "typical" APR quoted must be offered to two thirds of successful applicants - although the OFT has been made aware that these new rules may be being flouted "Risk-based pricing" means lenders tailor the rates to an individual's credit history. Some people will not qualify for the advertised rate and so will be offered a more expensive deal Stuart Glendinning, the director of personal loans at moneysupermarket.com, says although there are more than 30 loans available at the moment at under 7 per cent only customers with an excellent credit record are likely to benefit "Other customers with a slightly poorer profile may find it more difficult to achieve marketleading loans now than would have been the case a year ago.
These consumers should tread carefully, as applying for many loans will leave a footprint on their credit score, making it harder for them to successfully apply for further finance.
Top lenders for a £3,000 personal loan of less than 7% typical APR
|Loan provider||Typical APR||Amount repayable over 3 years without payment protection||Amount repayable over 3 years with payment protection|
|Northern Rock Personal Loan||5.7%||£3265.56||£3493.80|
|Moneyback Bank Personal Loan||5.7%||£3265.92||£3683.88|
|Nationwide Personal Loan||6.7%||£3310.20||£3635.64|
|Cahoot Flexible Loan||6.9%||£3319.56||Not quoted|
|Diners Club UK Personal Loan||6.9%||£3319.56||Not quoted|
|Leeds BS Personal Loan||6.9%||£3319.56||Not quoted|
|Ryanair Personal Loan||6.9%||£3319.56||£3806.28|
|VirginP ersonal L oan||6.9%||£3319.56||£3806.28|