Personal loans are booming as thousands of households try to cut the cost of borrowing by consolidating debts.
One lender reckons that one in three new personal loans will be spent on repaying other borrowings.
That adds up to 157,000 households borrowing £1.5 billion at an average £9,800 per loan, says Sainsbury’s Bank, one of the leading personal loan providers.
However, anyone considering debt consolidation needs to watch they are really are cutting the costs of borrowing.
One tactic of personal loan firms is to encourage borrowers to take more cash than they really need by making larger loans cheaper than smaller advances.
This can lead to some borrowers increasing their debts and paying more interest, as the loan is over a longer repayment period than cards and debts that are being replaced.
Independent financial research company Defaqto disclosed average interest rates for loans of £5,000 increased over the 12 months to January, whereas the average rate for borrowing £10,000 decreased.
The data shows the average interest rate for a £5,000 loan increased from 12.6% APR to 13.2%; but average rates for loans of £10,000 decreased from 9.8% to 9.2%.
Borrowers should look beyond the headline interest rate at other factors that could affect the cost of the loan:
• Lenders who leave a credit application search notice on the borrower’s credit file can knock their credit score and make make borrowing more expensive
• Check whether the interest rate is fixed or variable - variable rates can be changed at will by the lender and do not guarantee the monthly payment amount for a household on a tight budget
• Arrangement fees can put up the cost of borrowing - one in five lenders charges a fee that can add an extra £200 to the loan
• Look for early repayment charges - if a loan is settled early, 78% of loans want an extra payment ranging from 30 to 58 days extra interest.
Anyone consolidating debts because they can’t afford their existing unsecured borrowing may be eying the wrong solution - a financial management plan may be more effective.
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