Avoid This Appalling Loan Rip-Off!

Be very careful when choosing a personal loan, because this rip-off will bump up your repayments by 20% or more!

This article was first sent to Fools as part of our Good, Bad And The Ugly email series.

Recently, in Will Loans Get Cheaper?, I reported that interest rates on personal loans have risen by at least a third since early 2007. Around eighteen months ago, Best Buy loans charged interest of well under 6% APR. Today, thanks to the credit crunch, table-topping loans come with an interest rate closer to 8% APR.

Obviously, the higher your interest rate, the higher your monthly repayments and the more you repay overall (all other things being equal). However, if you choose the wrong type of personal loan, then your interest bill could be the least of your problems...

Payment protection insurance (PPI) -- a protection racket

When shopping around for a personal loan, you're sure to be offered payment protection insurance (PPI). This is a type of insurance which only kicks in if you have an accident, get sick or become unemployed. It ensures you can continue to meet your loan repayments.

In today's credit-crunched economy, it's understandable that you might want to take out such insurance. But is worth it?

Your lender will try to convince you it is. Although PPI is entirely optional, lenders usually give it the hard sell, largely because it is incredibly profitable. Indeed, it's not unusual for lenders to charge premiums of five or ten times the underlying cost of the policy.

To make matters worse, this insurance premium is added to your loan and interest is charged on it. Thus, you are forced to borrow yet more money in order to protect your original loan. This explains why profit margins on PPI can be as high as 80% to 90%, making it one of the UK's biggest financial fiddles.

The high price of PPI

Take a look at the table below, which starkly reveals the sky-high cost of protecting your monthly repayments. It shows the monthly repayments for a loan of £10,000 over five years, with and without PPI:

Source: Fool.co.uk's independent, unbiased loan search engine

As you can see, adding PPI increases your monthly repayments by over a fifth (20%), or more than £40 a month. Thus, over the sixty months of your loan, this protection will cost you around £2,500 in additional charges. Frankly, by charging such hugely inflated premiums, lenders are fleecing borrowers.

The low-cost alternative

I've been waging a war on rip-off PPI for nearly six years and, since 2003, one name has consistently featured in the Best Buy tables for stand-alone, independent PPI. It is Fool Partner British Insurance, which is beating the banks by selling good-value PPI.

For example, its award-winning loan protection insurance for a 30-year-old worker costs a mere £6.50 a month to cover a repayment of £200. Therefore, over five years, this policy comes to just £390, which is a saving of around £2,100 on the banks' own insurance.

Putting it another way, loan cover from British Insurance adds just 3.25% to the cost of your loan, compared to the 20%+ charged by lenders. So, to avoid being swindled by your bank, don't pay six times as much as you need to for accident, sickness and unemployment insurance!

Compare personal loans at Fool.co.uk