Be a savvy borrower in 2010

Find out what the New Year holds for borrowers who are looking for a personal loan.

Personal loans have grown increasingly expensive as the crisis-ridden economy struggles on. At the beginning of 2008, the most competitive loan charged  just 6.5% APR (based on £5,000 borrowed over three years). These days the cheapest loans are closer to 9% with average rates rising beyond 12%.

Why have loan rates risen when the base rate has fallen? Because loan providers have no guarantee that a borrower won't fall into default, and in a post-credit crunch world, loan providers are more risk-averse than they used to be. Remember, personal loans aren't secured on an asset - unlike homeowner loans which are secured on property. So they're not top priority debts for many people who run into trouble. And, as the threat of higher unemployment lingers, and the risk that a borrower will default increases, rates get more expensive.

It's enough to make me wonder whether personal loans are still a sensible way to borrow.

The loan market today

On the upside, despite rates climbing across the board, some competitive deals remain. But on the downside, these products are available on an increasingly limited basis. In fact, the market-leading loans are usually offered exclusively to existing customers of the lender. So for example, if you have an existing loan, current account or loyalty card with the loan provider.

This is fine if you just happen to fall into these categories - but many other borrowers are being left out in the cold. Personally, I find exclusive products very irritating as I explained in my recent video on Why existing customer only deals aren't fair. But at least it means there are a handful of decent deals out there for a select few - and there are ways to get around the 'existing customer' trap.

To illustrate what I mean, take a look at the table below, which shows today's best buy loans and indicates which are available to new and/or existing customers:

Top six personal loans - £10K repaid over 60 months

Nationwide Building Society has recently launched a new personal loan with a market-leading rate of 7.6% APR (typical) on loan amounts of £7,500 to £15,000. Unfortunately, it's open on a very restricted basis to Nationwide current account customers who have the Nationwide Flex Account.

Thankfully, Alliance & Leicester doesn't operate any of this exclusive nonsense. Its personal loans are available to new and existing customers alike, and offer the next best rate of 7.9% APR (typical) on loans of £7,500 and £14,950.

You'll get a similar deal at Sainsbury's Finance but once again these loans are only available to borrowers with a Nectar Card. Having said that, it's free to get a Nectar card and you can apply online in seconds. I think it's well worth doing to qualify for such a preferential loan rate.

Smaller loans

Remember, that the rates shown in the table apply to larger loans. But what rates can you expect to pay if you want to borrow a smaller amount? Alliance & Leicester is currently offering a top rate of 8.7% APR (typical) to borrowers who want to borrow £5,000 over three years. Meanwhile for loans of £3,000 over three years, the best place to look is Abbey with a best buy rate of 11.9% APR (typical).

Is there a better way to borrow?

You'll see that smaller loans tend to come with much higher rates, which means if you're planning to make a specific purchase, you may be considerably better off taking an alternative path.

For example, you could choose a 0% on purchases credit card instead, where you can enjoy interest-free credit on a temporary basis.

If you have a Tesco Clubcard - or you're willing to apply for one - try the Tesco Clubcard Credit card which offers the most competitive interest-free deal on everything you buy for the next 12 months. But this method of borrowing will only work for you if you can fully repay your debt in the short-term. After a year the rate shoots up from zero to 16.9% APR making it vastly more expensive than most personal loans.

Low rate credit cards

If you need more time to repay your debt, the MBNA Platinum Low Rate visa card could be the perfect solution. This card offers a fantastic rate of 6.7% APR on all your purchases (as well as balance transfers and money transfers) which easily beats all the top personal loans.

But there are a couple of drawbacks: first, the rate is variable whereas most loan rates are fixed. This means the cost of your debt could feasibly spiral before you've had a chance to repay it in full. And second, the card is available on a limited basis to the first 1000 customers. If you're tempted, you better be quick! To find out more about this card check out our video: The best lifetime balance transfer credit card.

If you can't find what you're looking for in the conventional loan or credit card market, you could try borrowing through Zopa. Zopa is an online company which allows you to borrow from other people rather than banks. You may be able to find cheaper rates here if you have a good credit rating. Find out more in this video.

Finally, once you've decided the best way to borrow, join our Destroy your debt goal to help you repay what you've borrowed more quickly. And don't forget, if you're after debt advice, head over to Q&A where you can ask other lovemoney.com readers for help.

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More: Six top tips for an affordable loan | The best and worst ways to borrow money