Beware Of The Sting In The Tail!

When finding or switching a personal loan, watch out for the penalties that lurk in the small print!

As I explained in an article earlier this month, the usual healthy competition for customers wanting a personal loan turns into a frenzy in January.Indeed, in order to drum up more business and win greater market share, many lenders slash their rates at this time of year. However, choosing the perfect personal loan involves much more than checking the headline rate of interest. For example, as I warned in Don't Pay £1,000 Too Much, you need to watch out for misleading APRs (annual percentage rates), rip-off payment protection insurance and other ruses.Another pitfall to beware of is the early-settlement penalty imposed on borrowers who pay off their loans early. Given that seven out of ten personal loans are settled early, these fines add up to a sizeable sum. Indeed, according to a report from financial firms MoneyExpert and Defaqto, over 672,000 borrowers were stung by loan penalty fees totalling tens of millions of pounds in 2005.The good news is that the infamous and unfair Rule of 78, previously used to calculate early-settlement penalties, was abolished last May. These days, the maximum penalty is capped at one month's interest, although the settlement date can be deferred by a month. In effect, the maximum penalty comes to two months' interest. Sadly, this new rule applies only to new loans. Borrowers with loans opened before last May won't benefit from this change until 2007, and those with loans lasting for more than ten years will have to wait until 2010.So, if you repay your debt ahead of time, you could end up paying up to two months' interest for the privilege. On the other hand, some leading lenders don't impose any early-settlement penalty, particularly those which offer so-called flexible loans. Using the Moneyfacts search wizard, I found nineteen loans which don't charge these penalties, the cheapest of which were:Lender Total amountrepayable (£)Typical APR (%)Northern Rock5,447.525.8Newcastle BSSaffron Walden BSSkipton BS5,501.526.5The AA 5,524.566.8(Based on a loan of £5,000 over three years without payment protection)For the record, the cheapest loan which charges an early-settlement penalty (from Fool Partner Moneyback Bank) costs £5,424.48. This is £23 cheaper than the cheapest no-penalty loan and £77 cheaper than the next cheapest. In other words, if you go for the cheapest loan on the market and do happen to pay it off early, you'll end up better off than with most penalty-free loans.Finally, the above report also found that almost eighteen million adults (three out of every eight) are planning to review their finances this year. If you're one of these sensible folk, be sure to take extra care when looking to replace an existing loan or find a new one. Why not let the Fool's search wizard do the hard work for you?More: Check out the great rates and special offers in our Personal Loan and Credit Card centres!