Loan rates are racing up

Loan rates have shot up over the past two years. Mike Kielty reveals why the rates have increased, and what you can do to find the best deal.

Figures released by Sainsbury’s Finance earlier this month suggest that the average rates for personal loans rose by 8.3% between September 2008 and September 2010.

They made a like-for-like comparison of loan providers offering deals at both these times, and found that the average rate on these loans had gone up from 13.2% to 14.3% APR.

In total, 62.5% of the loan providers increased their personal loan rates, at a time when the Bank of England has reduced its base rate from 5% to 0.5%. From 2008 to 2010, one in seven people suffered a rise in their personal loan rate of over 20%.

So why are these loan rates increasing, and what can you do to get the best deals?

Fewer providers means less competitive rates

The number of loan providers (normally banks and building societies) has declined by 40% over the past two years, with the result that the whole loans business is far less competitive than it once was. That means rising prices and bad deals for customers.

Paying back loans could become even more difficult now. It also gives you something to think about if you are looking for a new loan.

We’d always advise you to think carefully before taking out a loan for obvious reasons. You don’t want to be caught in a position where you can’t pay the money back. And there are alternatives. You can save up the money, or perhaps cut down on your spending elsewhere.

But if you are certain that a loan is the best deal for you, then there are a few things you can do to get the best deal.

What can I do to find the best loan rates?

As we explained in Six top tips for an affordable loan, there are lots of ways that you can get a loan at a rate that is affordable.

When looking at loan deals, always focus on two figures in particular: the APR (Annual Percentage Rate) and the TAR (Total Amount Repayable).

The APR shows you the rate of interest for the loan. Generally, you are looking for the lowest APR available, as this means you will have to pay back less in the long run.

But, crucially, the value that is advertised is normally described as a “typical” value. As the name implies, this advertised rate does not apply to everyone. In fact, the legal obligation for the loan provider is just that it has to apply to two thirds of customers for that loan.

This means that if, for instance, you have a bad credit rating, it’s likely that a bank may choose to make you pay a higher rate of interest than is advertised with the loan.

So, with APR, you’ve got to bear in mind that the rate that is advertised may not be the rate you are offered, especially if you've had problems getting credit in the past.

The TAR tells you exactly how much you will have to pay back, in total.This will assume that you take the full amount of time to pay the loan back and, as a result, pay all the interest as well.

So, for example, with the Nationwide BS Existing Customer Personal Loan, if you borrowed £10,000 over five years (60 months) at an APR of 7.5%, your TAR would be £11,952.60.

This makes it very easy to work out how much interest you'll pay: £1,952.60 in this case.

It’s also very important to check whether a loan is secured or unsecured. A secured loan means that you will need to offer up an asset – like your house or your car – as a security on your debt. Loan providers like this kind of plan, because it means that they have something to take from you if you fail to pay the loan back.

Secured loans can be helpful, as they allow you to borrow more than you would with an unsecured loan (where you don’t provide any of your assets as security).

But this is a high risk strategy. If you fail to pay back the loan, you could lose your asset. Imagine losing your home because you can’t pay back the bank! The APR also tends to be higher - 10.4% was the lowest APR I could find for a secured loan (the NEMO Secured loan deal), while the lowest for an unsecured loan was that one from Nationwide Building Society at 7.5% APR (for existing customers only).

The best deals at the moment

Here’s a table of the best five deals available for a loan of £10,000 (to be paid back over five years) on the basis of their APR.

More: Best ways to borrow £250 to £25,000!