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 types of charges are:
- Early repayment penalties
These are effectively fines of one or two months' worth of interest, charged when you repay the remaining balance early. So on a £5,000 loan over five years this could easily be £100.
- 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.
Payment protection insurance
If you've got a loan, check whether you were sold payment protection insurance (PPI) with it. While for some it's useful protection, many have it unnecessarily due to pressure/assumptive selling. That's because it's often more profitable for lenders than the loan itself.
If you don't think this applies to you, check.
One way PPI's mis-sold is by not telling people it's been added. As it's part of the loan repayments, you could be paying £1,000s too much, without knowing it…
What to do if you've got PPI
- Do you need it? Check whether you really need the policy. PPI is supposed to cover your repayments, usually for a year, in the event of accident, sickness or unemployment. Could you meet the repayments another way? Plus if you're self-employed or unemployed, it may not actually be covering you anyway.
Even if it is suitable, if you got the PPI from your lender, it's likely you're paying up to four times more than is necessary for it. So see if it's possible to ditch and switch to save. Full details in the Cheap Loan Insurance guide.
- Were you mis-sold it? If you were sold inappropriate loan insurance, it's possible you can get all your money back. There's been widespread mis-selling of these policies; read the PPI Reclaiming guide for more.
Many people who've tried to repay loans with PPI early have been told it'd cost them enough to burn out a calculator. This is because the lender assumes you borrowed the cost of the whole insurance upfront, and therefore must pay interest on it too.
In recent years the regulator, the Financial Conduct Authority (formerly the Financial Services Authority), has come down heavily on this, so cancelling existing policies is much easier now. If you were effectively stopped from cancelling it the past, you may have a mis-selling case.
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
To narrow down your selection, slide the slider to display the results
|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 over 16 months at the equivalent of 6.3% APR. This is far cheaper than the standard loans below, full step-by-step in the Cheap Credit Card Loans.
|£1,000 - £1,999|
Santander* 18.9% rep APR
|£2,000 - £2,999||
Post Office 14.9% rep APR
|£3,000 - £4,999|
Tesco* 12.8% rep APR
(for flexible repayments)
|Cheapest standard rate||Lender & Representative APRs
See all official APR examples
|Cheapest standard loans for £5,000 - £7,499|
Tesco* 6.4% rep APR
Santander* 6.8% rep APR
|Cheapest standard loans for £7,500 -
HSBC 4.8% rep APR (current account holders only)
Derbyshire* 5% rep APR
Nationwide* 5.9% rep APR (current account holders only) or 6.2% rep APR for everyone else.
Before you apply, Nationwide will tell you the rate you'll get if accepted, via a credit 'soft search', so you avoid a higher than expected rate and a wasted credit check(but it could still reject you).
|Cheapest standard loans over £15,000|
Barclays 5.7% rep APR (current account holders only)
Nationwide* 7.3% rep APR for current account holders only or 7.4% rep APR - everyone else
Before you apply, Nationwide will tell you the rate you'll get if accepted, so you avoid a higher than expected rate and a wasted credit check(though it could still reject you).
|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 add the debt to a remortgage, though that often means extending the term, more interest and securing the debt on your house.