Want to cut the cost of your current loan? Sadly, it isn't as simple as it seems. Switching to a new loan, even at a lower rate, can sometimes cost you more.
This cost-cutting guide will show you how to find the best new deal, and features a unique loan switching calculator so you can see if you'll really save.
Please note, this article is about unsecured loans, ie, the type sold by most high street lenders. The issues surrounding secured loans, products of last resort that most people should shy away from, are even more complex. So this article is a secured loan-free zone.
What are the problems with switching?
Sadly, switching loans isn't like transferring a credit card balance. Most loans are inflexible beasts usually designed to be repaid over the full term. Thus if you try to pay yours off early, a raft of hidden costs can skew any possible savings.
The main two charges depend on when you took out your loan:
- Early repayment penalties
If you've taken out a loan since June 2005, it's likely there'll be some early repayment penalties. These are usually one or two months interest, but the only way to know what you'd be charged is to ask your lender, as early repayment charges vary depending on how long your loan has to run, and how much you're paying off.
- Rule of 78
If your loan was taken out before June 2005, there could be a further hidden penalty, due to the old-style Rule of 78 interest calculations.
These were abolished for new loans from 1 June 2005, yet the British Bankers Association has confirmed that anyone with a loan from before then needs to check with their lender to see if Rule of 78 applies. This hideously complicated formula artificially allocates early years' repayments towards the interest, hardly decreasing the amount you owe.
This means if you attempt to repay in full early, there'll be much more left than you think. The earlier you repay, the bigger the problem.
When is it worth shifting?
The simple answer is… when it saves you money. The difficulty is calculating when that happens, as just getting a loan at a lower rate doesn't always work. If you can find a cheaper loan than your existing one, it's worth plugging its details into the calculator below to see if you'll save.
STEP 1: Find the correct info from your current lender
Before plugging your info into the loan calculator, you'll need to call your existing lender to ask it a couple of questions.
ASK: What are my exact monthly repayments and how many months do I have left?
This allows you to work out, by multiplying the figures together, how much you've got left to repay. For ease of calculation, just enter the figures below.
ASK: How much would it cost me to settle up right now?
What you want to know is how much it'd cost including all penalties, to repay the loan in full immediately. This is called the settlement figure.
STEP 2: Find the cheapest possible replacement loan
To switch loans, you'll need to borrow the settlement figure from the new lender. As the interest rate you get depends on the amount you need to borrow, it's important to have this figure before doing the calculation. To find the cheapest loans for that amount, read the cheapest loans section.
If you just want to do this quickly, you can try various options in the calculator to find what rate you'd need to get to be able to save, so plug the numbers in!
If I come into a windfall, should I pay the loan off?
A standard MoneySaving rule of thumb is always pay off any debts before stashing any money in savings (read Pay off Debts with Savings). In general, this is true with loans too, though due to the repayment penalties you may be financially better off by sticking it in a high interest account and drip-feeding loan payments out of there.
So if the 'total repayment' figure of your loan is £5,000, yet to keep repaying it each month costs £5,100 in total, you only gain £100 by paying it off now. Stashing the loan repayments in a top savings account could earn you more (See Instant Access Savings). However, if in doubt of the calculations, always err on the side of clearing your debts.
The cheapest loans to switch to
Quite simply, provided you don't get payment protection insurance, find the loan with the lowest representative APR (annual percentage rate) of interest for the amount you're borrowing. For much more information about the current best deals, read the full Cheap Loans guide.
Beware though, all the top loans compared below are representative rates. This means only 51% of those accepted actually need to be given these rates. Depending on your credit score, you may pay a lot more (see Lower Credit Scorers' Loans if that's an issue).
MSE Loan Finder
Select the amount you wish to borrow
To narrow down your selection, slide the slider to display the results.
|Cheapest standard rate||Lender and representative APRs
See all official APR examples
|The cheapest loan for smaller amounts using a credit card||
A few specialist credit cards can effectively be turned into lump sum loans, eg, £3,000 at 0% for 32 months, though there's a 4% fee. This is far cheaper than the standard loans below, full step-by-step in the Money Transfers.
|£1,000 - £1,999|
|£2,000 - £2,999||
Hitachi* 7.9% rep APR for £2,500 - £2,999 only (2-5 year term)
Post Office 14.9% rep APR for £2,000 - £2,999
|£3,000 - £4,999||
Hitachi* 7.7% rep APR for 2-5 year term
The AA* 7.9% rep APR (plus get a year's free AA breakdown cover)
(for flexible repayments)
|Cheapest standard rate||Lender and Representative APRs
See all official APR examples
|Cheapest standard loans for £5,000 - £7,499|
Hitachi* 5.3% rep APR for 2-5 year term
|Cheapest standard loans for £7,500 -
HSBC* 3.9% rep APR (from £7,000, current account holders only)
Hitachi* 4.1% rep APR for £7,500 - £10,000 only (2-5 year term)
Tesco* 4.1% rep APR
The AA* 4.1% rep APR for 2-5 year term (plus get a year's free AA breakdown cover)
|Cheapest standard loans over £15,000|
First Direct 4% rep APR (1st Account holders only)
Hitachi* 5.7% rep APR for 2-5 year term
The AA* 5.8% rep APR for 2-5 year term (plus get a year's free AA breakdown cover)
|Cheapest standard loans for over £25,000||
Maximum personal loan borrowing is £25,000. If you need more, be very careful, it's a huge commitment. You can combine loans, or remortgage, though that often means extending the term, more interest and securing the debt on your house.