Money Insider: Be clever: borrow more but pay less

By Andrew Hagger
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The Independent Online

if you want a loan to help with the cost of your home improvements or to change the family car, a personal loan from your bank or building society is often the cheapest option. But, bizarre as it may sound, it may actually save you money by borrowing more than you need.

Most banks and building societies stagger or tier their interest rates dependent on amount borrowed, with the general rule being the larger the loan, the lower the interest rate.

If the amount you're looking to borrow is close to the crossover point for the next tier, this is where it can sometimes be cost-effective to borrow that little bit extra.

For example a lender may price its loans as follows: £1,000-£2,950 = 17.9 per cent; £3,000-£5,000 = 13.9 per cent; £5,000-£7,450 = 9.9 per cent; £7,500-£25,000 = 6.9 per cent.

Currently, a £7,000 loan over a five-year term from Marks & Spencer Money is advertised at a rate of 12.9 per cent APR with repayments of £156.39 per month. But if you were to borrow an extra £500, the advertised rate drops to 6.9 per cent APR, and the monthly repayments are lower at £147.41. Therefore, borrowing an additional £500 will save you £538.80 over the full 60-month term of the loan.

Similarly with AA Financial Services, the rate on a £7,500 loan is 4 per cent APR cheaper than a £7,000 loan, and as a result it works out £129 cheaper to borrow £500 more over five years.

It's also worth bearing in mind that the tier structure will vary from lender to lender, so it's worth checking competitor rates as you could significantly reduce your interest charges by borrowing elsewhere.

If you're looking to borrow a smaller sum, you're likely to be put off by the high interest rates: for example, the average rate for a £3,000 loan is now a staggering 19.1 per cent APR.

A cheaper alternative for amounts between £1,000 and £3,000 is to be smart with your plastic. You could make your purchase by credit card and then switch it to a 0 per cent balance transfer deal. There are plenty of long-term deals available. In fact, just this week MBNA launched its longest-ever interest-free balance transfer card, giving you 0 per cent for 19 months subject to a one-off transfer fee of 2.5 per cent.

With a growing choice of long-term interest-free promotional offers currently available, there's a good opportunity for you to clear your borrowing in full before the 0 per cent offer expires.

Think carefully before fixing your mortgage

The co-operative Bank has recently re-entered the long-term fixed mortgage market with a new 10-year loan priced at 5.29 per cent with a £999 fee, or a no-fees option at 5.69 per cent, both available up to 75 per cent LTV.

Although a long-term fixed-rate mortgage provides security and peace of mind and in the right circumstances is an invaluable option for some borrowers, it can also prove an expensive choice when compared with some of the tracker rates currently on offer.

The mortgage market has been responding to consumer concerns about the cost of exiting a tracker mortgage before expiry.

With interest rates predicted to remain stable for the next 12 months, increasing number of lenders are now offering tracker mortgages that give you the flexibility to be able to switch to a fixed-rate product at a later date without having to pay an early repayment charge.

Woolwich from Barclays, Coventry BS and Yorkshire BS are among a number of lenders now offering this facility. It's a way of tempting people away from standard variable rate deals by letting them fix their rate without penalty when rates start to increase again.

When you look at the cost comparison, you'll understand why entering into a 10-year mortgage may not be a wise move at present.

A £130,000 mortgage at the Co-op rate of 5.29 per cent (25-year term) would require monthly repayments of £782 per month, while £130,000 with a Yorkshire BS tracker mortgage with drop lock option at 2.29 per cent would cost just £570 per month. You are looking at a significant difference of £212 per month, or £2,544 over the course of a year.

While stability of repayments will appeal to some people, you also need to consider the early repayment fees of up to 6 per cent of mortgage balance, should your circumstances change in the next 10 years and you need to exit the deal early.

Consumers on a very tight budget may be tempted by a longer-term fix, but with base rate predicted to remain stable for the time being, it looks too soon to lock in right now.

Andrew Hagger – Moneynet.co.uk

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