10 traps to avoid when taking out a loan

Taking out a new loan can be fraught with dangers. Here are the ten costliest booby traps to watch out for.

Unsecured loans are one of the most simple products there is, but the finance industry still manages to squeeze in a good number of extra ways to make money from you. I've counted many traps so, before you buy, read here for what I think are the biggest ten:

1. Small and fleeting

The temptation with loans, particularly if they're being actively sold to you, is to go for an even bigger sum than you first thought. What's more, the lender will often convince you to drag out the loan for longer to reduce the monthly repayments. They're not being helpful; they're trying to earn more money over a longer time frame. When you pay debt interest, you'll never get it back, so you want to make the loan as short and small as possible to keep down those costs.

2. Fix it

Most unsecured loans have fixed interest rates, but you do have to watch out for the occasional variable rate loan. Look for the word 'fixed'.

3. Compare the TAR, not the APR.

The annual percentage rate or APR (e.g. '16% APR') is meant to be a standard way of comparing the cost of a loan over a year. However, the APR can be manipulated by the lender, so the best way to compare the cost of a loan is to look at the total amount repayable or TAR. This is the total cost including interest and charges that you will pay from your first payment to your last. You should also ensure that you can afford the monthly payment.

4. It's not all about cost

Look for better T&Cs. With unsecured loans, this normally means that you're allowed to make overpayments or that you're not charged if you want to pay off the whole loan early. Those generous terms are rare, but they do exist, so keep an eye out for them.

5. No arrangement fees

It's the total cost – the TAR – that is the most important figure. However, you also want to know if this includes charges other than interest, such as an arrangement fee. If you pay an arrangement fee and want to get out of the loan early, the costs will have been skewed to the start of the loan and so  it will have been deceptively expensive.

Thankfully, most unsecured loans don't have arrangement fees any more, but you must still read the small print.

6. Consider alternatives

You should compare an unsecured loan with your most likely alternatives. The first and best, if possible, is saving up to buy later, but otherwise you can use credit cards to get good, interest-free deals or low fixed interest rates, or you can borrow from Zopa.

However, if you go for a loan, ensure you cut up any existing credit cards and close the accounts. The majority of people who don't go on to rack up more debts on them, and regret it.

When using credit cards, arm yourself first against the score of booby traps they contain by reading Beware these 19 credit card tricks.

7. Hidden tick boxes

Find those hidden tick boxes that refer you to dodgy secured lenders. Several unsecured loans contain them. Sometimes you have to read through the Privacy Policy to find the box hidden there. If you don't change the tickbox, the lender can reject your application and pass on your details to other lenders, who will send you details of some expensive, variable loan with poor terms and conditions, all in return for a fat commission. It's happened to our readers.

8. Don't trust your bank

Do you trust your bank to have your best interests at heart?

Thought not, but that doesn't stop some people from being persuaded to take out a loan from their own bank. Your own bank will almost never offer you a competitively cheap loan, simply because it finds it so easy to sell expensive products to its existing current-account customers.

However, you could ring up other financial companies that you already have relationships with to see if they'll offer you any special deals. This has been known to work surprisingly often. Compare any offers with comparison tables.

9. Avoid PPI

Cliff D'Arcy, another writer for this website, has campaigned hard for years about payment protection insurance, writing more than 400 articles on the subject for us since 2005, and bringing it to the attention of the wider media with some success.

Lenders like to add insurances to protect your repayments in the event of accident, illness or redundancy because they're extremely expensive, typically adding £2,000 to £3,000 to the cost of a £10,000 loan. They also have poor terms and conditions.

Your best alternatives are usually:

• Don't take out the loan
• Keep some savings for emergencies
• Buy the insurance from a stand-alone provider, who will charge one-tenth of the price and normally with better terms and conditions
• Consider instead a different (but similarly-named) insurance, income protection insurance.

10. Avoid gimmicks

Loans should be simple products, but lenders like to entice you with such things as cashback and payment holidays. Loans with cashback are inevitably more expensive, particularly if you want to pay off the loan early, as you'll lose the cashback. Payment holidays (which is when you can take a month or two off payments) are really sneaky in that the interest will still build up in that time, and it will increase your repayments for the rest of your loan. Such a break is surprisingly expensive.

Make it easier on yourself

Here at lovemoney.com, our loans comparison tool makes it easy to see the total cost (TAR), the monthly cost, arrangement fees, whether you can overpay, and any gimmicks.

Compare loans at lovemoney.com

More: Three ways to get an interest-free loan | Top loans for all borrowers