On the surface, getting a loan should be a straightforward process, but there are so many factors that can affect the final price paid. Hence, looking for the cheapest loans takes time and effort.
The best deals available will be offered to those customers with a good credit profile, but even they can get lower rates of interest (and hence monthly payments) by taking out a secured loan rather than an unsecured loan.
Secured loans are available for larger amounts borrowed over longer periods and, although the rate of interest will be lower (due to the additional security for the lender), the costs of setting up the loan will be charged to the borrower.
Loans under £10,000 will probably be unsecured for most borrowers, meaning that there will be a few extra add on costs other than an administration fee. Secured borrowers may have to pay for independent property valuation and registration fees, although these may be added to the loan and repaid over time.
Lenders look for a particular profile of customer, so comparing terms offered can be important in getting an application approved. Good credit profiles will have the widest choice, whilst those with a poor credit history can expect to pay a premium to borrow and have a shorter repayment period.
This means that for a similar £5,000 loan, a poor credit profile customer may pay an additional £2,000 in interest and fees over the life of a five year loan. Therefore prospective borrowers should do everything possible to improve a credit profile before applying for a loan as this can save many pounds.
Checking credit information costs just £2 or may even be free through one of the credit reference agencies. Several offer a free one month trial, which allows an easy to see view of the credit information held so that any incorrect information can be challenged.
Another additional cost to consider is the addition of payment protection insurance (PPI). There has been a large amount of bad press relating to the sale of PPI by banks but it can be a worthwhile addition provided it is properly explained at the time of sale and the customer qualifies for cover.
Self employed people and those with pre-existing medical conditions or previous knowledge of impending redundancy will not be eligible. There is also at least a six month qualifying period before a claim can be made.
On the plus side, PPI policies will make monthly loan payments if the worst happens. Extreme care needs to be exercised before taking on the additional cost of a PPI policy.
One measure of the cost of a loan is the stated APR (Annual Percentage Rate). This adds in all fees and charges and makes a standardised calculation as to the true cost of credit.
This is a fair comparison for loans over a year in duration, but can give some high values where short term loans are taken out.
Since the APR calculation looks at the cost per annum, a short pay day loan of 20 days, for example, could have a rate approaching 2,200%.
Some loan companies also have a policy of charging fees for missed payments or when loans are in arrears. Make sure to check what could be charged as an administration fee or late payment fee should a payment be missed. These can soon amount to a considerable sum and will not be included in the APR stated.
The final true test is the monthly repayment plus any fees paid. Rather than relying on APRs alone, always check the amount of the payment and the number of payments to be made, plus any additional fees.
Check what happens in the event of a default and it should be possible to flush out all the potential hidden costs.
Sam is a finance writer based in the UK, currently working for Moneysupermarket.com
The Hidden Extras of a Loan by Steve