Choosing The Right Loan

If you're looking for a personal loan, here are some ideas on how to go about choosing one.

Borrowing money is, sadly, a fact of life for many of us and when it requires a larger-than-usual lump sum for something like home improvements or a car, it's the personal loan market that most of us turn to.

Although we're getting better at shopping around for good deals, people often just go straight to their own bank for a loan because they think it's the easiest route. But it's just as easy to get a loan from a lender you've never used before. To that end, here's a checklist of the sort of things you should be watching out for:

Compare interest rates

In spite of the recent rise in interest rates, there are still some very competitive loans on offer. It's always worth starting off by comparing the Annual Percentage Rates (APRs) to see which loans are the cheapest but that's not the whole story. APRs can be manipulated so it's more important to compare the total amount repayable. These show how much in pounds and pence that you will have to pay back so the loan with the lowest total amount repayable over the period of borrowing will invariably be the best deal. Make sure the interest rate is fixed for the term of the loan too - you want certainty about how much your monthly repayments will be, so avoid variable rates that could be increased at any time at the whim of the lender.

Consider repayment periods

The longer you take to pay off a loan, the more you'll pay overall. You may like the idea of paying less each month by opting for a longer timescale but it'll cost you. So, go for the shortest period possible whilst ensuring that you can comfortably make the monthly repayments.

Use an unsecured loan

Any lender proposing to hand over money secured against your house will invariably spout the warning that: "Your home is at risk if you do not keep up with repayments". It may seem like a mere technicality but you should take that mantra seriously because lenders mean it! It's imperative that you appreciate that you could be forced to sell up to pay the loan back if your ability to make the repayments goes awry.

Pay off early

Around 70% of loans are paid off early and until recently, borrowers were usually rather taken aback by high early settlement costs. Thankfully, the government has put a stop to the old method used by lenders to calculate settlement figures and new loans taken out since 31st May 2005 are restricted to early settlement charges of, at most, two months interest. Unfortunately, loans for terms of ten years or under which were in place before that date will only be covered by this rule from 31st May 2007. Those for terms of more than ten years won't be covered until 31st May 2010.

Avoid Payment Protection Insurance (PPI)

Amazingly, around 7.5 million PPI policies are taken out every single year on the basis that they protect your ability to maintain repayments should you be unable to do so because of accident, sickness or unemployment. Unfortunately, they rarely offer real value for money because people rarely claim on them and when they do, they often find they don't qualify anyway because they're not usually ill or unemployed for long enough. As PPI can add as much as a third again to the total repayment bill, they're best avoided. An income protection policy is a better bet than taking out individual policies for the mortgage, credit cards and loans - at least you'll be able to all your bills rather than just one of them.

Compare loans here at the Fool.