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Thursday, 11 January 2018

Taking Out a Loan: 10 Things to Consider

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The following is a guest post by Neil Faulkner, freelance journalist. This article was originally posted on and adapted for US audiences with permission from lovemoney.com, a popular money management online publication in the UK.
 Taking out a new loan can be a dangerous endeavor. Here are the ten costliest traps to watch out for when taking out an unsecured personal loan.
Unsecured personal loans are the simplest products there is, but the finance industry still manages to squeeze in a good number of extra ways to make money from you. I’ve counted many traps so, before you buy, read here for what I think are the biggest ten:

1. Small and fleeting

The temptation with loans, particularly if they’re being actively sold to you, is to go for an even bigger sum than you first thought. What’s more, the lender will often convince you to drag out the loan for longer to reduce the monthly repayments. They’re not being helpful; they’re trying to earn more money over a longer time frame. When you pay debt interest, you’ll never get it back, so you want to make the loan as short and small as possible to keep down those costs.

2. Fix it

Most personal loans have fixed interest rates, but you do have to watch out for the occasional variable rate loan. Look for the word ‘fixed’.

3. Compare the TAR, not the APR.

The annual percentage rate or APR (e.g. ‘16% APR’) is meant to be a standard way of comparing the cost of a loan over a year. However, the APR can be manipulated by the lender, so the best way to compare the cost of a loan is to look at the total amount repayable or TAR. This is the total cost including interest and charges that you will pay from your first payment to your last. You should also ensure that you can afford the monthly payment.

4. It’s not all about cost

Look for better T&Cs. With personal loans, this normally means that you’re allowed to make over payments or that you’re not charged if you want to pay off the whole loan early. Those generous terms are rare, but they do exist, so keep an eye out for them. Make sure you understand any fine print before you take the loan.

5. Origination fees

It’s the total cost—the TAR—that is the most important figure. However, you also want to know if this includes charges other than interest, such as an origination fee. When comparing loans, make sure you include the origination fees charged by all options you are considering.

6. Consider alternatives

You should compare an unsecured loan with your most likely alternatives. The first and best, if possible, is saving up to buy later, but otherwise you can use credit cards to get a short term low interest rate. If you have good credit scores, you can also score lower rates going to peer-to-peer lending sites like LendingClub.com in the US or Zopa.com in the UK.
If you use a personal loan to pay off other debts, ensure you cut up any existing credit cards and close the accounts. Avoid the temptation of using your debt-free credit cards and rack up more debts on them. You will regret it.
Overall, be careful of 0% or low introductory rate credit card offers as they are full of fine print and traps.

7. Privacy issues

When applying for a personal loan, make sure you read through the Privacy Policy. Some institutions may reject your application and pass on your details to other lenders in return for fat commissions.

8. Don’t trust your bank

Do you trust your bank to have your best interests at heart? Thought not, but that doesn’t stop some people from being persuaded to take out a loan from their own bank. Your own bank will almost never offer you a competitively cheap loan, simply because it finds it so easy to sell expensive products to its existing current-account customers.
Instead, shop around. Visit sites like Bankrate.com to compare the latest published rates before you apply. Ring up other financial companies that you already have relationships with to see if they’ll offer you any special deals. This has been known to work surprisingly often.

9. Understand other add-on terms

Some loans come with specific terms in case you miss or default on the loan. Costs associated with payment protection insurance, collection fees and late payment penalties must be understood before you take out a loan.

10. Avoid gimmicks

Loans should be simple products, but lenders like to entice you with such things as cashback and payment holidays. Loans with cashback are inevitably more expensive, particularly if you want to pay off the loan early, as you’ll lose the cashback. Payment holidays (which is when you can take a month or two off payments) are really sneaky in that the interest will still build up in that time, and it will increase your repayments for the rest of your loan. Such a break is surprisingly expensive.

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