The Best And Worst Loans

More personal loans are taken out in January than in any other month. However, the wrong loan could leave you thousands out of pocket...

Around this time of year, there's always a big jump in borrowing as consumers rely on credit to cover the cost of Christmas and New Year festivities.

Alas, as I warned in Is Your Overdraft An Ogre, millions of us end up paying sky-high charges for slipping overdrawn during January. As well as being a bumper month for overdraft charges, January is also the biggest month of the year for providers of personal loans. On average, more than 500,000 personal loans are taken out each January, which explains why several lenders advertise special `loan sales' at the start of the year.

However, choosing the wrong personal loan could leave you nursing a nasty New Year hangover. Indeed, if you don't tread carefully, then you could be out of pocket to the tune of thousands of pounds. That's because the cost of personal loans varies enormously, thanks to a wide range of interest rates and the extortionate pricing of rip-off payment protection insurance (PPI).

Take a look at the following loan tables, provided by Fool partner Moneyfacts, which show the total amount repayable (TAR) for the UK's cheapest and most expensive loans:

Borrowing £5,000 over three years (without PPI)

So, according to Moneyfacts, the difference between the cheapest and most expensive unsecured personal loan for £5,000 over 36 months is £482.40. That's enough to treat a family to a nice weekend break.

Even more frightening, through other research I've found that some lenders offer similar loans at 18% to 19.5% APR, which would cost you £6,502.68 to pay off, or £985.68 more than the cheapest! (Beyond rates like that, of course, we can start getting into the even dodgier loan-shark-type loans.)

Now let's look at the best and worst loans for £10,000:

Borrowing £10,000 over five years (without PPI)

In this example, the extra interest payable jumps to £1,719 over five years, or close to £30 a month more. Again, Northern Rock is at the bottom of our table, but Sainsbury's Bank takes top honours this time.

Borrowing £25,000 over five years (without PPI)

Once again, Yourpersonalloan.co.uk takes the top spot, with Northern Rock bringing up the rear. In this example, the difference between the interest charged by these two loans is massive: a total of £4,198.20 over five years. So, pick the wrong loan to pay for, say, some home improvements, and you could be over £800 a year worse off!

I can see two interesting things in the above tables. First, the crisis at Northern Rock has taken it from the top of these tables to the very bottom. Once a leading provider of Best Buy personal loans, Northern Rock has now effectively withdrawn from this market. Second, you pay a lower rate of interest borrowing £10,000 from Sainsbury's Bank than you do borrowing £25,000 from Yourpersonalloan.co.uk. Normally, the more you borrow, the lower your interest rate, so this is an unusual quirk.

The great PPI rip-off!

The above tables compare the cost of the cheapest and most expensive loans without payment protection insurance. That's because adding PPI to your loan massively increases your outlay, as my next table reveals:

As you can see, adding PPI to your loan dramatically increases its cost. Indeed, on almost every occasion, the cost of PPI is greater than the interest bill. Even the cheapest PPI increases the cost of your loan by at least a tenth. That's because profit margins on PPI are massive, with around 80% to 90% of your premium going to the providers in commission. That's far too steep a price to pay for this shoddy protection, so I'd give it the boot every time!

If you feel you need some protection against accident, sickness and employment, then don't buy PPI from any lender. Instead, shop around for stand-alone cover provided by a Best Buy independent supplier, such as award-winning Fool partner British Insurance.

Alternatives to a personal loan

Before you rush off to the Fool's personal loan centre to search for the perfect loan, ask yourself whether this is the right product for you. If I were looking to borrow money for up to fifteen months, then I'd prefer to avoid paying any interest by using a 0% credit card. For borrowing over longer periods, I'd make use of lifetime balance transfers, where rates are as low as 5% a year.

Finally, beware of consolidating (rolling up) your existing debts into `one easy monthly repayment'. As we warned in this article, this way to get out of debt really only works if you are disciplined and are willing to stop over-spending and borrowing for good!

More: Five Top Credit Cards | How To Find £100 A Month | Beware Of Rate Rip-offs In 2008