When a personal loan is the right way to borrow
With 0% and low rate credit cards often seen as the cheapest ways to borrow money, it's easy to overlook the humble personal loan.
In fact, since the start of the credit crunch, personal loans have had a pretty bad press. The Bank of England base rate is at an all-time low of 0.5%, yet many banks have begun to charge customers higher rates on loans over the past year.
However, there are some circumstances in which personal loans are a brilliant way to borrow. They offer benefits that credit cards cannot, and may be more suitable for some individuals than a 'flexible friend'.
In this article, I'll outline five situations where I think taking out a personal loan might make sense.
1. When you can get a market leading rate
Firstly, it's important to remember that, while the average cost of a personal loan may have increased since last year, there are still some attractive deals available for those who'd prefer not to use a credit card.
Right now, the market's cheapest loans come with APRs of around 8% - and although that's significantly higher than the Bank of England base rate, it's roughly half the standard APR charged by most credit card providers!
A current market leader is Alliance & Leicester's personal loan, which charges 7.9% APR (typical) on loans of £7,500 to £15,000.
2. When your other debts are more expensive
If you're planning to borrow to consolidate existing borrowing, there are a variety of options you could consider. 0% balance transfer deals and long term, low rate credit cards are tools that have helped thousands of people deal with expensive debts.
However, personal loans can also seriously undercut the cost of old balances. A deal such as that from Alliance & Leicester could slash the interest payments on a typical credit card balance by around 10 percentage points, or reduce the cost of store card debt by up to 22 percentage points!
Before pursuing any kind of debt consolidation, however, it is important to understand that you shouldn't clear old balances with a new loan or credit card just for the sake of bringing your borrowing together.
Only pay off balances that are costing you more than your new loan (or credit card) will. If you add cheaper debts into the mix without thinking, you will actually increase how much it costs you to clear them!
3. When you need to borrow a substantial sum
If you need to borrow a substantial sum of money, it may make more sense to use a personal loan than a credit card.
One reason for this is that borrowers are unable to state the exact credit limits they need when applying for new plastic. This could mean that, even if you are accepted for the card you want, you are left without the money you need.
Conversely, personal loan applications allow individuals to be specific about their requirements. For example: if you know you'll need £8,000 from your bank, you can apply to borrow this exact sum over a period of time that will suit you.
It's worth noting that, as a general rule of thumb, personal loans of £7,000 and above tend to come with cheaper APRs than loans for smaller amounts. However, this is no reason to borrow more money than you need.
Don't forget that, even if you managed to access a lower interest rate by doing so, you'd be paying that rate on a larger lump sum. As a result, you'd be less likely to save in the long term.
4. When you need a structured plan for repayments
When they're handled cleverly, I think credit cards are fantastic financial products.
0% balance transfer cards, long term, low rate deals and 0% purchases promotions can all help slash the cost of borrowing if they're used correctly.
Nevertheless, some people run into problems with credit cards. Most demand that borrowers pay back only a small percentage of their total balance each month, typically around 2-3%.
If people choose to, they are free to repay more. However, this flexible approach to repayments can mean less disciplined borrowers run up large bills which may take many years to clear.
Only ever paying your credit card's monthly minimum repayment (MMR) may mean your debts last decades, as Victoria Bischoff explains in this article.
On the other hand, taking out a personal loan will tie you in to a specific interest rate and a strict repayment plan that has an agreed start and end date. From the day you draw down your funds, you'll know how long it will take you to pay back what you've borrowed and how much your loan will cost you.
5. When you may not be accepted for a 0% purchases credit card
Thanks to the effects of the credit crunch, credit card providers are now far pickier about who they will - and won't - lend to. Therefore, it's a good idea to check your credit history before applying for a market leading deal such as a 0% purchases or balance transfer credit card.
Should you find there are blemishes on your borrowing past, trying to get a top card may do you more harm than good.
If you are rejected for the deal you want, there will be a recent 'footprint' on your credit file that is visible to other lenders - and this may put them off giving you the credit you need.
If you're in any doubt that your credit rating is very good, applying for a personal loan may yield a better result than opting for a 0% deal.
Although you may have to pay more in interest for your borrowing, targeting your application in this way - perhaps even by opting for a slightly more expensive loan than the market leader - may mean it is more likely to be successful.
**This material is for information purposes only and should not be considered financial advice. We strongly encourage our readers not to rely solely on this content, but to seek independent advice when making financial decisions.**
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