Christina Jordan investigates whether you should you go for a credit card or a personal loan when you need to raise cash.
This article has already been emailed to Fools as part of our Summer Lolly campaign.
If you don't have savings and you need to make a large purchase this summer, your main choices are to use a credit card or a loan.
The bad news is that all forms of borrowing have increased in cost over the last year. According to Moneyfacts, 14 loan providers increased their personal loan rates last month alone.
And credit cards have also been crunched. According to MoneyExpert average standard rates have risen by 0.6% from 16.8% to 17.4% since February this year despite two Bank of England rate cuts.
However, the market-leaders in both sectors are still offering competitive products and Fools will be able to find decent deals if they look hard enough.
But which is best for a £5,000 debt - plastic or loan?
Loan rates may have increased but they are still lower than standard credit card rates. Because of this loans are useful for anyone who is not planning to repay their debt quickly and does not want to switch credit cards to chase the best rates.
The most competitive loans charge just under 8% and there are a number of providers in this category. Based on a debt of £5,000 repayable over five years the following come out best:
Provider | Typical APR | Total repayable | Monthly repayment |
|---|---|---|---|
7.6% | £5,989.80 | £99.83 | |
Your personal loan.co.uk | 7.6% | £5,989.80 | £99.83 |
Barclaycard | 7.8% | £6,016.20 | £100.27 |
Plastic fantastic
Credit cards offer a good solution to borrowing £5,000, especially if you are prepared to switch. There are two options that stand out.
- Keep on switching: Buy your purchase with a 0% purchase card, and then move onto a new card with a 0% balance transfer rate for a typical period of around one year. When that rate runs out, switch again, and keep switching.
Pros: You will effectively pay no interest, enabling you to pay off your debt more quickly.
Cons: You will attract a balance transfer charge of around 3% each time you switch. It's also possible that you will be flagged as a `rate tart' and may find it difficult to be accepted by a provider, although this is unlikely given the competitive market.
- Just switch once: Buy your item with a 0% purchase card and then switch to a lifetime balance transfer card, which guarantees a rate of interest until the debt is repaid.
Pros: The interest rate you pay will be much lower than a standard credit card and the average loan rate, plus you only need to switch your balance once, saving on fees.
Cons: You will attract a one-off balance transfer fee, increasing your effective interest rate in year one by around 3%.
For your initial purchase you will need a 0% purchase card. The market-leader is Capital One Platinum, which offers 0% on purchases until November 2009. This gives you 15 months interest-free on purchases - the longest on the market. Other decent 0% purchase periods include 10 months from Halifax All In One Mastercard - this also offers 0% on balance transfers, so there is no negative payment hierarchy.
If you then want to switch to a 0% balance transfer deal there are plenty to choose from. Those that offer the longest 0% periods include Capital One Platinum (up to 1st December 2009), Virgin (15 months) and Barclaycard Platinum (up to November 2009).
If you want to switch to a life of balance transfer rate, the card with the lowest rate is Citibanks's Platinum Itunes Rewards card, which charges annual interest of just 4.9% until the debt is repaid. However, this comes with a one-off 3% transfer handling fee, making your initial rate in 7.9% in the first year.
So you may be better off going for the Barclaycard Platinum lifetime balance transfer card, which offers a life of transfer rate of 6.5% - with no handling fee.
Finally and most importantly, do not be tempted to make more purchases on your card if you have transferred a balance on to it. Purchase rates will be higher and many cards operate negative payment hierarchy. This means that your monthly repayments pay off the cheap interest-free portion of your debt first, costing you more overall.
Not a very Foolish move at all.