Five cheap loans that are true best-buys!

Don''t be fooled by the best-buy tables. Neil Faulkner explains how to find a true low cost loan.

Personal loans are a simple product, but they still manage to be more costly than they say on the tin, which makes it difficult to compare them using most best-buy comparison tables. I’ll explain how, and then I’m going to show you what the real best buys are in the whole market.

The five loans that are considered best

Firstly, using the Annual Payment Rates (APRs) supplied from the personal-loan providers, these are the loans that the best-buy tables would have you believe are the best, if you wanted to borrow £8,000 over the next five years:

*I’ve rounded the pence in the Total cost column.

I’ve deliberately excluded loans that are only available to existing customers. Just be aware you need a Nectar card for the Sainsbury’s loan - but you can get one of those for free in five minutes.

The problems with best buy tables

There are at least two problems with these figures that I can identify, and they play havoc with any attempt to truly compare the cost of the loans.

Firstly, most lenders tend to charge a few pounds extra per month. This is perhaps down to how they calculate interest. By calculating interest on a daily basis, the borrower builds up interest arrears every day. At the end of the first month, when the first repayment is due, an extra £50 or so in interest has already accrued. Interest is then charged on top of this till the end of the loan.

The next problem is that some loans come with compulsory payment holidays. (Otherwise known as ‘deferred periods’.)

A payment holiday may sound like a good thing, but because you’ve delay your first payment for an extra few months, interest builds up during that time. Throughout the length of the loan, more interest will be charged on top of that interest.

As a result, you’ll need to make a couple of extra repayments after the period you applied for. If you apply for a 60-month loan, for example, you’ll end up having to continue to make repayments 61 or 62 months after the holiday finishes.

The APR is supposed to make comparing the cost of loans easy, but here we have just a couple of ways that it can be manipulated. Not only do these sorts of things make a mockery of APRs, but also of the actual repayment figures.

That’s why I always ignore APR and look at the real cost. Factoring in the above, here’s how the best-buy loan tables should really look right now:

The five cheapest loans in the entire market (for real)
Again, my calculations are based on an £8,000 loan over five years.

By comparing the two tables, you’ll notice that all the figures have gone up and that the AA ‘best buy’ loan disappears completely from the top five in my ‘true best buys’ table. This is because it defers the first payment for three months and therefore racks up more interest.

The credit crunch wasn’t all bad

Thanks to the credit crunch, most banks want to start getting their money back as soon as possible after they’ve lent it to you. That’s why so few loans have compulsory payment holidays at the moment, and why my second table is not dramatically different from the first one. Still, it’s nice to have the real figures.

When the banks are experiencing better times, more of them can afford to leave the entire loan outstanding for several months and let you build up more debt interest. I’ll keep an eye on this situation and update you as things develop.

What can you do?

In the meantime, you can take care of yourselves. Before you apply (and therefore get marks on your credit rating) establish whether there is a compulsory payment holiday (or a compulsory deferred period). Avoid those loans unless the quote is comparatively extremely cheap.

Some loan providers, such as Tesco, Asda and Sainsbury’s, offer the choice of a deferred payment: you decide if you want to delay your first repayment for a few months. Perhaps this is useful to you and worth the extra cost, but remember that it doesn’t come cheap.

Other loan providers, such as Alliance & Leicester, let you choose the date of your direct debit. If you can, you should choose to make your first loan payment as soon as you receive the money. This should bring down the cost, because interest builds daily. Alternatively, you could try to borrow less in the first place!

Compare loans at lovemoney.com

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