Loan insurance: don't push the boat out

As banks tempt us with cheap deals on big purchases, they're also trying to talk us into protecting our repayments. Does this bring security, asks Sam Dunn, or is it a rip-off?

It doesn't matter if it's for a luxury cruise, a tummy tuck or flashy car - prices are low and you should get one while you can. Unless you have buried your head in the sand for the past six months, that's the message you'll have been battered with in adverts for personal loans on TV, radio and the internet, in the street and across your newspaper.

It doesn't matter if it's for a luxury cruise, a tummy tuck or flashy car - prices are low and you should get one while you can. Unless you have buried your head in the sand for the past six months, that's the message you'll have been battered with in adverts for personal loans on TV, radio and the internet, in the street and across your newspaper.

With annual percentage rates (APRs) as low as 5.8, they're selling like hot cakes, according to Richard Mason of moneysupermarket.com, the financial information website.

Demand has surged by 60 per cent in the past year: "Our website is seeing 6,000 applications for personal loans each day," he says.

Churchill, the insurer, estimates that the UK's personal loan market was worth a staggering £80.2bn in 2003.

Finding a competitive deal is simple - an internet search yields a hatful of offers on low APRs, some with payment holidays.

But before you buy the loan, you'll have to decide whether to insure your repayments. These monthly premiums - known as payment protection insurance (PPI) - cover you if illness, accident or unemployment leave you unable to meet your commitment.

Two out of three of us tick the box and take the insurance, the industry estimates. Yet more of us should stop to consider the expense. PPI can add hundreds of pounds to the cost of a loan and industry opinion is divided over its value, although regulation in 2005 will mean clearer on costs for consumers.

Mr Mason calls the insurance "a complete rip-off" and warns that lenders are more desperate than ever to make money from personal loans.

Ferocious competition has kept the cost of loans down, while Bank of England interest rate rises have squeezed lenders from the other side. "It's now even more important" that PPI is sold, says Mr Mason.

Loan insurance is just another product that preys on our desire for peace of mind, says Sue Hannums at independent financial adviser (IFA) Chase de Vere. "The PPI is sold to us rather than bought; banks make a lot of money from us taking this out."

But lenders stand by the cover, insisting that it is useful.

Alliance & Leicester's website, for example, has a page of "frequently asked questions" about personal loans which warns readers that "over 500 people are made redundant in the UK every day, and 60 per cent of unemployed people are out of work for six months or more".

So who's right about PPI? And should you bother to take it out?

The first thing to watch out for is a loan quote that automatically includes PPI. Insurance broker Stoke has unearthed evidence that many lenders routinely incorporate insurance in their quotes. Worse, this cover is, in many cases, "nothing short of a scandal" because of many exclusions, it says.

Stoke's survey reveals that loan salespeople fail to ask relevant questions about, say, a customer's medical history or whether they are self-employed. This is crucial information because a part-time job, an existing serious illness or short-term employment can exclude people from making claims on their policy.

"You have to know what you are buying with the loan insurance. Some of the [terms] can be very strict," Ms Hannums says.

Alliance & Leicester's website, for example, lists "main exclusions" - such as illnesses that you knew about before taking out the loan - but a full list is only available on request.

Check also to see if the PPI will cover repayments for the life of the loan or might run out after, say, a year.

For example, if you can't make your Lloyds TSB loan repayments because of an accident, you'll be covered for the term of the loan. Become unemployed, however, and the cover only lasts for 12 months.

In the midst of all this, ask yourself whether you really need PPI anyway. If you meet certain criteria, you probably don't. With savings worth six months' salary and a decent sick pay scheme at your employer, "you should probably have enough" says Ms Hannums.

And if you are self-employed, an income protection policy should offer adequate cover - and can provide for mortgage payments too.

Watch for the time lapse, though, says Ms Hannums. "Income protection doesn't pay out straight away - the wait can be considerable. If you go for cheaper cover with a 26-week wait before any payout, you'll need resources to be able to pay during this time."

If you still want to cover your loan with insurance, at least ring around brokers to see if it will come cheaper than from the loan provider.

Don't forget you can cancel the PPI if you change your mind; typically, there is a "cooling-off period" of 30 days from taking it out.

The Financial Ombudsman Service says it had about 800 PPI complaints last year - a small percentage of overall grievances - and that 40 per cent of those were upheld.