Last Of The Low Rate Loans

It looks like we've seen the end of sub-7% personal loans for the time being, but this form of borrowing still offers good value for money.

It doesn't seem that long ago that we were warning that sub-6% personal loans could soon be a thing of the past. Now it looks like we've seen the end of those below 7% as well.

According to Moneyfacts, two years ago the lowest interest rate you get on a £10,000 personal loan was 5.6%. This time last year it had risen to 6.1%. As of today though, the lowest rate you can get is 7.2% from the AA.

Why have rates risen?

This is obviously not great news and you won't be surprised to hear that the infamous credit crunch is behind the rise. There is another factor at work here though and that's the ongoing onslaught against the high cost of payment protection insurance sold alongside personal loans.

There's no readily available data on how sales of this product have fared over the last couple of years but I suspect they may have fallen quite significantly. Considering that it's payment protection insurance and not loan interest where most of the profits are made on personal loans, it's perhaps surprising that loan rates haven't risen by more than they actually have.

The cost to your pocket

In terms of pound notes, the effect of the increase in personal loan rates is a lot less than you might expect. A £10,000 loan over 5 years would have cost you £191 a month in the summer of 2006. This time last year the monthly cost was £193 and now it is £198. Of course, the vast majority of personal loans have fixed interest rates so anyone who took out a loan at lower rates has seen no rise in the amount they pay. But for new borrowers the rise in monthly payments compared to two years ago has been less than 4%.

Contrast this with the rise in monthly mortgage payments if interest rates go from 5.6% to 7.2%. A £100,000 repayment loan would go from £620 a month to £720, an in rates go from 5.6% to 7.2%. A £100,000 repayment loan would go from £620 a month to £720, an increase of 16%, while the same size interest-only mortgage would go from £467 a month to £600, an increase of 28%. As mortgages are paid back over much longer periods, changes in interest rates have a much greater impact on the level of monthly repayments.

Loans still good value historically

A look back at the history of personal loan rates also puts the recent rise in their interest rates into perspective. According to the Bank of England, back in 1995, the average rate for a £10,000 personal loan was over 17%! Cheaper rates were available back then but many of us went direct to our bank to get our personal loans and paid through the nose for the privilege. An interest rate of 17.5% translates into monthly payments of £244 for a £10,000 loan taken out over five years.

As recently as 2002 the average rate for new personal loans was still as high as 12%. Rates plummeted in 2003 as more and more of us started to search online and find that significantly cheaper loans were available from smaller lenders rather than big banks. The average rate for new loans has remained around the 7% to 9% level ever since, although the current average rate for is near the top end of that range.

What will rates do next?

The only way is up I suspect, in the short term at least. It seems likely that the base rate will rise rather than fall over the next twelve months. Banks are still reluctant to lend money so there will be fewer lenders looking for our business, making it all the more important to shop around for the best rate. Stricter application criteria will make it harder to get the lowest rates that are advertised.

I think the fall off in payment protection insurance sales will continue to be a factor too. In fact, I wouldn't be surprised to see the interest rate for the cheapest £10,000 loan hit 8% or even 8.5% by the end of this year. This would add another £5 to the monthly repayments required for a new five-year loan.

If you want to borrow less than £10,000 the picture is a little gloomier. Although you can get a £5,000 loan at 7.3% there are only a third as many lenders offering rates below 8% when compared to £10,000 loans. If you're only looking for £3,000, then only a couple of lenders are offering less than 10% with the cheapest being 7.9%.

We're paying around 15% on our credit card borrowing at the moment and probably slightly more than that for overdrafts. (That said, you can borrow much more cheaply if you can get a 0% credit card.)

Secured loans, as they're normally targeted at those with chequered credit histories, are more expensive than personal loans and they come with additional fees and non-fixed rates of interest. Mortgages are a longer form of borrowing so are not directly comparable but soaring arrangement fees are making them a less attractive way to borrow.  

So for those who need to borrow, relative to most other forms of lending, personal loans still look like pretty good value.

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