How a personal loan could demolish your debts

Personal loans require more commitment from borrowers than credit cards, our formerly 'flexible friends'. However, using one could help you deal with your debts once and for all. Laura Starkey explains…

As an optimist, I like to believe that every cloud has a silver lining. Right now, of course, it's difficult to see how the British recession could spell good news for anyone.

Unemployment is increasing, home repossessions are on the rise and consumer confidence is so low that even shopaholics are steering clear of the high street.

But there is one bright spot on the horizon: the shock of sinking into an economic slump has forced many of us to consider dealing with our debts.

The burden of borrowing

If you feel weighed down by credit and store card debts, one of your first priorities should be working out exactly how much you owe, and how much interest you are paying on your borrowing.

Once you're armed with that information, you can set out a strategy for demolishing your debts as cheaply as possible.

If your debts are unmanageable (for example, if your monthly disposable income won't cover the repayments on what you owe), you might need to seek independent advice. The Consumer Credit Counselling Service, National Debtline and Citizens Advice are all organisations that will offer you help and support for free.

However, provided you can afford to make the necessary repayments on your debts, there are several ways you could save money while reducing what you owe.

You could consider shifting your existing debts to a 0% balance transfer credit card or a lifetime balance transfer credit card (you can read more about them here).

In this article, I'm going to explain why paying off expensive old balances with a new personal loan could also be a good choice.

Why a loan might work

The cost of a market-leading personal loan could still seriously undercut the standard interest rate charged on a credit or store card.

The best personal loan rates currently available are around 8% APR. That's about half the standard rate you might be charged on a credit card and up to 22% less than the cost of a store card debt over 12 months.

Furthermore, I think a personal loan is an option worth considering if you feel you need a structured repayment plan to help you clear your debt.

While balance transfer credit cards are often the cheapest tools to help batter down your borrowing, using them could see you end up in a pickle if you are tempted to keep spending on your card or don't pay it off as quickly as you'd planned.

Conversely, a personal loan provider will require that you agree to repay a certain sum each month for a set period of time.

If you take out a personal loan, you'll know exactly what your monthly payments will be and exactly how many months it will take you to deal with your debt.

Finding an affordable loan

Believe it or not, you're more likely to be able to access a cheap loan rate if you apply to borrow a larger sum. My general rule of thumb is that if you're looking to deal with debts of £7,500 or more, a personal loan could be worth considering.

This is because £7,500 is the threshold above which many lenders charge their lowest rates for personal loans.

However, you should always check the terms and conditions on offer from individual banks and compare a range of deals before committing to a loan.

Remember, your credit history will affect the loan rate you are offered so it's a good idea to check yours before applying for any form of credit.

Also, it's worth being aware lenders are only required to offer their typical rate to two thirds of applicants. The remaining third may be offered a more expensive deal.

Things to remember

Finally, don't forget to consider the following before you take out a personal loan:

Don't consolidate debts without looking at how much they currently cost you. Remember, it will cost you more to roll up your debts in one place if some of them are currently at interest rates below that you are offered on a personal loan.

• Only borrow a sum you can afford to pay back over a period that is realistic for you. However, be aware that the longer your repayment period is, the more expensive your loan will be overall - even if your monthly repayments are lower.

• The lender you choose may offer you payment protection insurance (PPI) with your loan. While it may be a good idea to take out this cover, it's likely you will get a cheaper deal by comparing PPI providers and buying a policy yourself - so as a general rule of thumb, I think it makes sense to avoid buying PPI direct from your loan provider.

• Last but not least, if you pay off credit and store card debts using a personal loan, it is a good idea to cancel them. This is an important step because having too much access to credit can damage your credit rating. Even more crucially, this will prevent you from running up new debts on those fiendish, flexible, so-called friends.

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