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Beware of the not-so-cheap personal loan

Beware of the not-so-cheap personal loan

Category: Loans

This article was correct at the time of publication. It is now over 6 months old so the content may be out of date.

Unsecured personal loans can be ideal for people who have debts to consolidate or who want to make a purchase with a fixed repayment plan. It's not surprising, therefore, that in the current low interest rate environment this type of finance is proving to be popular with many borrowers.

However, our latest research reveals that these loans may not always be the best option, particularly for low borrowing amounts; anyone looking to take out a smaller loan may be shocked by how much they'll be charged in interest compared to alternative forms of borrowing, so it's important to consider all the options before you take the plunge.

Small loan = high cost

Our data shows that the lowest rate customers could currently achieve on a small personal loan of £3,000 is 5.9% (a deal offered in branch by Metro Bank), which would result in monthly payments of £90.91 and total interest payments of £272.76 over three years.

However, if they were to put £3,000 on the best 0% balance transfer card, which has an interest-free term of 40 months, borrowers would only incur a £75.90 fee (2.53%), saving £196.86 in the process. Alternatively, transferring money from the best money transfer card would incur a £118.20 fee (3.94%), which would still save borrowers £154.56 versus the loan.

The table below highlights the options in more detail, and as you can see, if you only need to borrow a small amount, an interest-free credit card could definitely win the day:

£3,000 over 3 years Product and rate
Total interest
Best branch loan Metro Bank - 5.9% £272.76
Best online loan Ikano Bank - 7.3% £337.92
Average loan rate 15.1% over 3 years £749.15
Best 0% balance transfer card Virgin Money - 0% 40 months, 2.53% fee £75.90
Best 0% money transfer card Tesco Bank - 0% 40 months, 3.94% fee £118.20
Source: Compiled 20/06/2016

"One of the benefits of using a personal loan is its simple fixed repayment plan, which means borrowers know exactly how long the term is and how much they'll pay each month," said Rachel Springall, finance expert at Moneyfacts. "However, customers must be wary of borrowing smaller amounts of cash, as a small loan is unlikely to be as cost-effective as using a competitive interest-free credit card.

"In fact, borrowers could save almost £200 in interest repayments by borrowing via a best buy 0% interest balance transfer credit card, so the savings speak for themselves."

No guarantee

Not only can a loan be less cost-effective – despite the benefits of a repayment plan – but it's also important to point out that borrowers are not necessarily guaranteed to get the best rates for a personal loan. As Rachel explains, "lenders only have to offer advertised rates to 51% of successful applicants, which means that even the best loan can end up being an expensive option for those who fall outside of this charmed circle.

"Competition has really intensified in the interest-free credit card market, which is why a balance transfer card can be a great alternative for short-term finance, provided borrowers pay off the debt before interest applies. Borrowers will also have greater flexibility with their repayments on a credit card compared with a loan, which could be helpful in the event of a financial emergency.

"Whichever method borrowers choose they must be sure that they can comfortably afford to repay the debt. Loans and credit card debts leave a financial footprint, so keeping up with repayments and reducing debt is imperative."

What next?

Compare the best 0% balance transfer cards

Big purchase in mind? Check out the top 0% purchase cards

Personal loans could still be more cost-effective if you're looking to borrow a large amount of money – use our loan calculator to take a look

Remember that securing credit of any kind will only be possible if you've got a decent credit score. Compare credit check providers to see how yours stacks up

Disclaimer: Information is correct as of the date of publication (shown at the top of this article). Any products featured may be withdrawn by their provider or changed at any time.