Cut the cost of existing loans?
 

Switching loans means paying off your existing lender with money from the new loan, yet loans are inflexible beasts usually designed to be repaid over the full loan term. Attempt to repay early and often you're hit by two types of serious charges.

• Rule of 78
  
  A hidden penalty; most lenders use ‘Rule of 78' interest calculations. This is a hideously complicated formula which artificially allocates early years' repayments towards paying off the interest, so they hardly decrease the amount you owe.
  
  This means try and pay off the loan in full early and there's much more left than you think (see a Rule of 78 Technical Explanation). The earlier you repay, the bigger the problem.
  
  New rules have stopped Rule of 78 for loans taken out since June 2005, yet there's no respite for loans taken out prior to that.
  
  
• Early Repayment Penalties
  
  These are effectively fines of one or two months' worth of interest for not repaying over the full term. Worse still, the actual interest amount usually depends on a Rule of 78 calculation too, so the earlier you repay the bigger the penalty.
  
  
  

Payment protection insurance (PPI) bought to cover your repayments in the event of accident, sickness or unemployment is expensive and usually hugely profitable for lenders, often more so than the loan itself.

Try and repay loans with PPI early and the sums would burn out most calculators, as often they assume you borrowed the cost of the whole insurance up front and then use Rule of 78 to work out what you pay. This means repay an insured loan early and it's often possible you can owe more than you borrowed.

Some lenders allow you to cancel the PPI separately. If yours will, it's worth considering taking out a separate PPI policy (see Loan Insurance Cost Cutting).

A. Get it to confirm your repayments and ask how many remain.

Multiply the two together and this is the cost of sticking with your existing lender. E.g. 48 months at £150 equals £7,200.

B. Ask how much it costs, including penalties, to repay the loan in full immediately.

Use this as the base amount needed if you're switching. Take it to the new lender and ask for a quote over the same time period (or less if you can afford to repay quicker).

E.g. If it'd cost £6,350 to repay now, borrowing that over 48 months at 6% would cost £149 a month, £7,160 in total.

Then quite simply go for whichever option is cheapest in your situation (in the above example, it makes little difference either way).

If I come into a windfall, should I pay the loan off?

One of my MoneySaving Rules of Thumb is that you should always pay off any debts you have before stashing any money in savings. Yet due to the repayment penalties you won't necessarily be financially better off than just sticking it in a high interest account and drip feeding loan payments out of there.

For example. If the ‘total repayment' figure of your loan was £5,000 yet to keep repaying it each month was £5,100, then you only gain £100 by paying it off now, and stashing that in a top savings account (See Instant Access Savings) could earn you more. Then again the convenience and ease of ‘the debt being gone' could just overbalance the financial issues!

It's simply a case of finding the loan with the lowest APR (Annual Percentage Rate) of interest. The rate you get depends on the amount you borrow, yet a cheap rate isn't a reason to borrow more; never get a loan for more than you need and can afford to pay back.

• Borrowing over £15,000 - 6.8%. AA offers a rate of 6.8% for loans from £15k - £25k.
• Borrowing from £7,000 to £14,999 - 6.5%. Sainbury's offers a rate of 6.5% for loans over £7k.
• Borrowing over £5,000 - 6.7%. Moneyback offers 6.7% for loans from £5k.
• Borrowing over £4,000 - 6.8%. Barclaycard offers a rate of 6.8% if you're borrowing over £4k.
• Borrowing over £1,000 - 7.9%. Abbey* has a rate of 7.9% on amounts over £1k