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What to consider when taking out a personal loan

Written by Wesleyan.

Over the coming years, you may find you need to take out a personal loan. This could be for a number of reasons, such as buying a car, going on holiday or making improvements to your home.

There are plenty of lenders out there who may be prepared to let you borrow money, but it is important to do some research first to make sure you get the best deal that is right for you.

Here is a guide to help you get the best deal when you take out a personal loan.

1. ONLY BORROW WHAT YOU CAN AFFORD

It sounds obvious, but many people are tempted to over extend themselves when they borrow money.

When you take out a loan, consider the interest rates and monthly repayments and ensure you can afford to cover them.

2. SHOP AROUND FOR THE BEST DEALS

Many people stay with their bank for a lifetime and automatically go to them for a loan. However, your bank might not offer you the best loan deals, and you may find some banks have special offers for new borrowers that are not available to their existing customers, so it makes sense to shop around.

3. CHECK THE RATE OF INTEREST YOU WILL BE PAYING

It is important not to be drawn in by a lender offering low interest rates, as this may not necessarily be the rate you will end up paying.

You can find loans for £7,500 over four years with an APR (Annual Percentage Rate) ranging from 4% to 23.9%. While lower rates are attractive, they could have specific conditions that you might not be eligible for. For example, they might only be for members of a loyalty scheme or be available for a limited time to new customers.

It is also worth noting that if a lender’s promotional material describes the interest rate as ‘Representative APR’, this too might not be the rate you will receive. Regulations state only 51% of customers need to have received that rate for the loan or a similar product during the previous 12 months. The rest will have had a different rate, which could have been higher.

4. FIXED RATE OR VARIABLE?

Check whether the interest rates are fixed or variable. A fixed rate will apply throughout the term of the loan while a variable rate can go up or down depending on what happens to the Bank of England base rate.

5. LOW INTEREST RATES COULD BE COMING TO AN END

The Bank of England base rate, which is an important factor in how banks set their loan rates, has been at its historic low of 0.5% for more than five years.

However, this interest rate cut was put in place at the height of the recession in an attempt to stimulate economic growth and was never intended to be a permanent position.

In fact, in recent months the Governor of the Bank of England has indicated that interest rates could soon start to rise, perhaps before the end of the year.

While it is not known when rates will rise and to what levels, it is expected they will go up as the economy continues to recover, and so will increase the cost of borrowing. This means now might be a good time to take advantage of the low costs of borrowing.

6. BORROWING MORE COULD COST YOU LESS

While sensible borrowing should always be the main consideration, there are occasions where it could work out cheaper to borrow more.

Most banks charge higher interest for what they class as smaller loans, typically up to around £7,500. A difference of six percentage points between the rate for smaller loans and larger loans is not uncommon. If you are near the threshold, borrowing slightly more could mean you actually end up paying less over the term of your loan.

For example:

  • A loan of £7,000 over four years at 13.9%* APR has monthly repayments of £188.09, meaning the total amount payable is £ 9,028.32.
  • A loan of £7,500 over four years at 7.8%* APR has monthly repayments of £181.46, with the total amount payable being £ 8,710.08.

*Based on Wesleyan Bank interest rates, August 2014.

7. CLEAR YOUR DEBTS

It is good financial practice to ensure you do not build up too much debt and clear loans as soon as you can.

Some banks allow you to make overpayments in order to pay off a loan early. While some, like Wesleyan Bank, do not charge a fee for early repayment, other providers may, so you need to be mindful of any charges if you clear your loan early.

8. CONSOLIDATE YOUR DEBTS

Another way to reduce the amount of interest you pay could be to consolidate your debts into one larger loan rather than have a number of smaller ones. This will also leave you with a single repayment each month, which could help you to manage your personal budget. As long as you keep up with your repayments, a consolidation loan shouldn’t affect your credit rating. Again, check whether your loans have fees for early repayment, as any charges for paying them all off to consolidate may cancel out any advantages.

It should be noted that, in consolidating a number of debts then it is likely the repayment term will be longer in order to make the loan affordable. This can mean that while the monthly repayments will be smaller than you were paying previously, you will ultimately be paying back more over the period of the loan.

CONCLUSION

Many people will have to take out a loan at some point and it is important to research carefully to get the best deal.

The above information does not constitute financial advice. For more information or for specialist financial advice contact Wesleyan Medical Sickness on 0800 072 3749 or visit the website at www.wesleyan.co.uk/bank.