Should you always go for the absolute cheapest rate when choosing a loan - or are there other important factors to consider?
When it comes to choosing a loan, what do you look for?
Do you want the ease and flexibility of being able to pay it off as quickly as possible? Or are you reeled in purely by the numbers, and want a no-frills, cheap loan?
Depending on your preference, you have to consider whether you'd prefer to have a loan with fixed monthly payments, or whether you could be able to pay the loan off early, and hence need a more flexible loan.
This is because loans are a bit like train tickets - the more flexibility you need, the more expensive they will be.
So what are the main differences between the two types of loan?
Fixed Loans
Fixed loans are usually cheaper than their flexible counterparts. Everything is set in stone: you what you pay every month, and for how long.
If you're someone who likes to stick to a fixed monthly budget, this is ideal. However, if you want to pay the loan off early, fees will usually apply. This is generally one month's interest, although this can go up to 56 days.
Flexible Loans
As the name suggests, flexible loans offer... flexibility!
Like a fixed loan, you pay a fixed rate - so you know what you'll be paying every month throughout the course of the loan.
But, if you want to, you can pay off the loan at any time without penalty. You can also often delay your initial payments by up to three months, or even take a break from payments - known as a 'repayment holiday' - during the course of the loan.
This seems great on the surface. But unfortunately, you will still be charged interest on the loan during this time - and that means the loan will cost you much more overall than if you hadn't taken the holiday. (Read this article to find out more about this sneaky trick.)
What's more, because flexible loans give you more room for manoeuvre, they also tend to be more expensive in terms of the overall costs and interest rates (APR) they offer.
So, which is cheaper?
This table shows the cheapest fixed loans for someone borrowing £7,500 over a three year period (early settlement fees apply).
Provider | APR | Monthly Repayment | Total Repayable | Early Settlement Fee |
|---|---|---|---|---|
Barclaycard | 6.8% | £230.20 | £8,287.20 | One month's interest |
Masterloan | 6.8% | £230.20 | £8,287.20 | One month's interest |
6.8% | £230.20 | £8,287.20 | Two months' interest | |
6.9% | £230.52 | £8,298.72 | One month's interest. | |
Lombard Direct | 6.9% | £230.52 | £8,298.72 | One month's interest (apart from loan terms under 12 months where no fee applies) |
Source: Moneyfacts
This table shows the same amount and terms, but features flexible loans with no early settlement fees.
Provider | APR | Monthly Repayment | Total Repayable | Features |
|---|---|---|---|---|
Post Office | 7.9% | £233.73 | £8,414.28 | Optional two months' repayment holiday (not consecutive). Only available online. |
AA* | 7.9% | £236.72 | £8,521.92 | Payment holiday available at start of loan. Only available online |
Intelligent Finance | 8.9% | £236.95 | £8,530.20 | Optional two months' repayment holiday available. |
Egg | 9.9% | £240.17 | £8,646.12 | n/a |
Coventry Building Society | 12% | £246.92 | £8,889.12 | n/a |
Source: Moneyfacts
*Total repayment includes two month repayment holiday taken at start of the loan.
So you would save at least £127.08 (Barclaycard vs. the Post Office) over the term of loan, if you went for a fixed loan over a flexible loan.
That's effectively the amount you have to cough up in order to be able to pay off the loan early without incurring a penalty.
Unfortunately, the clear cut advantages stop here, and there is no black and white answer to whether getting a fixed or more flexible loan is better.
If you plan to take advantage of the repayment holiday option, and would like the option of being able to settle the loan early, then a flexible loan may well be a good choice for you.
Alternatively, if your top priority is to get the absolute cheapest loan, you will find you can probably get a lower rate if you opt for a fixed loan.
There are, however, some ways that you can ensure you get the best value for money whichever option you choose.
Playing Einstein
First and foremost, use a loan calculator to your advantage. Many loan companies offer tiered rates, with better rates attached to higher loan amounts.
For example, if you were to borrow between £3,000 - £4,999 on a fixed loan from Tesco Personal Finance, the typical APR is 15.9%, but drops to 9.9% for loans between £5,000 - £7,499.
That £1 makes all the difference, as borrowing £4,999 over a three year term would cost you £6,215, whereas borrowing £5,000 would only cost you £5,765 over the same term. That's a saving of £450.
Plus, all the flexible loan providers in the second table apart from the Post Office allow you to make overpayments to your loan. This you will save yourself a packet in interest payments, if you can afford to do it.
So, if you were really cunning and Foolish, it could be worthwhile borrowing more than you actually need on a flexible loan to qualify for the best APR, and then immediately repaying the surplus to avoid paying extra interest.
That way, even if you do only need to borrow a relatively low amount, you could still get a great deal.
A Word Of Advice
Remember that the APRs quoted are `typical rates', and are therefore not guaranteed (a typical rate means that it is offered to two-thirds of borrowers).
Before you consider any loan application, you have to think to yourself if you will actually qualify for the advertised rate, especially if you're looking to borrow big then repay some of the capital early. For further reading, Neil Faulkner looks into this in more detail.
Wherever you decide to get your loan, the moral of the story is to make sure you do your research. Don't be put off by the numbers.
Shop around, do the maths and double check the rate tiers offered by each company. That way, you really can say you bagged yourself a `best buy'.
More: Pricey Personal Loans
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