Personal loans increase but at what cost?

At one time, borrowing money from the bank would have involved getting out the best suit and grovelling to the manager. These days, banks ring customers at home and ask them if they want to take out a loan. In fact, they almost give you hard time if you’re not borrowing.

Just as it’s never been easier it’s also never been quicker. You can pick up the phone and arrange to borrow money as quickly as you could book a table at a restaurant.

About two-thirds of the way up, somewhere between a credit card and a mortgage, is the personal loan.

A credit card these days means being able to buy that must have dress or CD before pay day, but more expensive single expenses, such as buying a car, paying for a wedding or doing up a house, it’s the personal loan that has taken over.

While credit card borrowing fell by £300 million in mid 2006, net lending on personal loans and overdrafts rose by almost three times the amount seen in June, the latest statistics from the British Bankers' Association (BBA) show.

New credit card borrowing reached a four-year low reaching £7 billion, while personal loans and overdrafts grew in popularity, up to a net lending of £655 million. Director of statistics at BBA, said that despite the decline in mortgage lending, other means of borrowing of becoming more popular and convenient.

"Unsecured lending is displaying quite a different trend, with the growth rate continuing to decline, largely reflecting the ongoing contraction in credit card borrowing,” the director said.

In April, Moneyfacts said that while credit card transfers can offer cheaper rates than personal loans, people lacking discipline with their repayments could benefit from the structure a personal loan provides.

However, new research from uSwitch seems to indicate that the less you borrow on a personal loan in the UK, the more likely you are to be paying interest rates that are higher than the lender’s advertised Annual Percentage Rate (APR). The major lenders all apply penalties when borrowers look to repay early. Paying the loan early will automatically trigger a charge of £175. But the charges don't end there. Complicated small print explains that borrowers are tied into the loan for eight years. Loans can run for as long as 25 years given the amounts involved. But if you want to repay your loan within three years you will have to pay six months' worth of interest on the outstanding amount.

Given that some customers are paying as much as three to four times the going market rate for loans of higher amounts it is estimated that more than half a million Brits who took out banks loans of less than £5,000 in the last year are paying too much.

There may now be a very valid and justified complainant that they’re being unfairly hit by this policy of applying different interest rates depending on how much is being borrowed. Nonetheless, UK loans do still remain one of the cheapest possible ways for Brits to borrow large sums of money (over £5,000) and so the costs of funding for small loans (under £5,000) by UK banks should be viewed with caution. Shop around for the cheapest personal loan possible is also the advice of the head of personal finance at uSwitch, who notes that interest rates do remain highly uncompetitive on small loan amounts in the UK. This would appear to be the case regardless of whether or not the personal loan is secured or unsecured as UK lenders still apply a tier based system to the interest rates they charge. Alternative borrowing, such as a 0 per cent credit card, should also now be included in any alternatives you are looking at if you are considering taking out a small loan in the UK with a very limited repayment period.

Alternatively, it may just be the times for Brits to start thinking of borrowing larger sums of money just to help reduce the cost of the borrowing.