Why being an 'average' borrower will cost you

Average loan applicants can expect a worse than average rate, and yet top customers are getting better and better deals.

From early 2008, the Bank of England surprised economists (who walk around in a permanent state of raised eyebrows, it seems to me) by dropping the base rate by five percentage points in just 13 months.

By March 2009, the base rate hit a record low of 0.5%, and it has remained at this deep level ever since. However, in the following two-and-a-half years until today, the average unsecured loan has gone up in price, says financial research company Defaqto.

In spring 2009, the average advertised rate on a £10,000 loan was 9.8% APR, but now it is 11.2%, some 10.7 percentage points higher than the base rate. This massive spread will be shocking to anyone who took out a loan in the mid-noughties, since the spread then was just three or four percentage points, but bear in mind that spreads of seven to ten percentage points were normal back in the mid-90s.

What's more important to borrowers is how large our pay rises are while we're taking out and paying off our loans. A series of pay increases can make it easier to clear our debts. Unfortunately, in recent years we have faced pay freezes, pay cuts, less overtime, less opportunity for promotion, fewer new jobs, reductions to part-time work and, in many cases, complete loss of income through redundancy.

[SPOTLIGHT]This has all been happening at a time of high inflation, which means we also need more of our flat incomes to pay for essentials and emergencies – and that means we have less money to pay down our debts.

Average loan applicants do worse than average

While average interest rates have gone up, credit also remains more tight than it was prior to 2007.

With less money to go around and more emphasis on responsible lending, lenders have had to reject more applicants. Nationwide, which offers one of the lowest rates and has always been careful with who it lends to, has been rejecting 60% of applicants outright. (Anyone who needs to borrow can have a go at getting Nationwide's loan without it impacting their credit record. Read about it in Eliminate this new threat to your credit record.)

Rejections for top loans such as from Nationwide will inevitably be higher than rejections for more expensive loans. Some lenders will be less picky than the building society and might have more credit to offer, but reports over recent years have usually shown that at the very least 25% are being rejected, and often 40% or more.

Rejected applicants are the lucky ones. It used to be that lenders had to offer their advertised interest rates to two-thirds of applicants, but recently this has been reduced to a touch over half (51%). Hence, the other half (49%) of accepted applicants don't get the advertised interest rate. These borrowers, relieved to get a loan, might be accepting any old interest rates.

With so many applicants either rejected or offered higher-than-advertised rates, it is probably something closer to just 25% who actually get the cheap rate lenders tempt you with.

It's good news for top customers

Thanks to more borrowers paying lenders' secret, higher interest rates, the relative few borrowers with excellent records can get even cheaper top rates at their expense. The evidence shows that this is happening.

While average loan rates have risen, the top rates have fallen. Defaqto writes that top interest rates on £10,000 loans have fallen from 7.8% in March 2009 to 6.3% today, closing on the low at the height of the credit boom five years ago. Interest rates have fallen for all the top loans between £5,000 and £25,000, and have risen for smaller loans only.

Cheapest fixed-rate loans for £7,500 to £15,000

More: compare loans through lovemoney.com | Will you be forced to sell your home to repay a £600 debt?