Personal Finance: Borrowers, shop around

Need a loan? Make sure you get the best deal, says Caroline Laws

MOST PEOPLE need to borrow some money at some time, whether it is an extra pounds 1,000 to see you through Christmas, or a longer-term loan. But with so many sources of money, from overdrafts to personal loans, how do you work out which is the cheapest?

It all depends on how much you are borrowing and for how long. If, for example, you want to borrow less than pounds 1,000 and pay it off in six months, the cheapest way to do it is on a low-cost, no-frills credit card. Do not automatically run up an overdraft at your bank because if you have a high street account you will be paying around 18 per cent APR for an authorised overdraft and around 30 per cent for an unauthorised one. This compares with 6.9 per cent interest on money borrowed with a Capital One Bank Visa or Mastercard, (0800 952 5252), as long as you pay the money back by July 1999, when the rate increases to 17.9 per cent.

There are lots of cheap credit cards offering low introductory rates. They include: RBS Advanta Visa (0800 077 770) and Royal Bank of Scotland Mastercard (0800 161 616), offering 7.9 per cent; Nationwide Building Society (0500 302 011), offering 8.5 per cent on its Visa card; and Co- Operative Bank (0800 109 000), offering 8.6 per cent on its Advantage Visa card. None of these charge an annual fee but they will charge penalties if you miss payments.

Give store cards a wide berth because most charge a high interest rate if you fail to clear your balance. FraserCard, for example, charges 28.4 per cent on uncleared balances.

If you want to borrow money for longer, a personal loan can be better but you should think about how much you can afford to pay back each month after you have paid out your priority commitments, such as the mortgage. Try to take out your loan for as short a time as possible, says Damon Gibbons, from the Money Advice Association, which represents 700 advice workers, including the Citizens' Advice Bureaux.

A long-term loan is not generally a good idea as the interest you will pay is higher the longer the term of the loan. Personal circumstances are also more likely to change in the longer term and may affect your ability to repay.

When you are shopping around you need to make sure you are comparing like for like, and you should never base your choice on the headline rate quoted in adverts. To help you compare costs, lenders are required by law to quote an annual percentage rate (APR) figure. This is a more accurate guide to the total cost of borrowing than an effective annual rate (EAR), the charge quoted for most overdrafts (which are not required to quote an APR figure). The EARs take into account the charges for borrowing but not any fixed fees that may be added. Rates can therefore look artificially competitive.

If you are considering taking out a loan, get a full written quotation that explains in detail all the charges, including fees. Some loans, for example, charge penalties if you want to pay the loan off early.

Once you have chosen your loan, you can almost guarantee that your lender will ask you to take out payment protection insurance on top of the cost of the loan. In most cases this is an expensive waste of money. As our best buy table shows, on a pounds 5,000 loan paid back over three years, you will be paying around pounds 20 a month extra in payment protection. And you will be paying interest on the protection insurance.

Because unsecured personal loans are not underwritten, lenders rely on a hefty set of exclusions to avoid paying out. Mr Gibbons suggests that you check the small print to make sure the conditions match your circumstances. For example, some schemes do not cover the self-employed or people on short-term contracts.

And what if your spending has spiralled and you are tempted to consolidate all your loans into one big one? Mr Gibbons says: "This is rarely a good idea, particularly if the consolidated loan is secured on your home. At the end of the day your home is placed at risk."

If you are worried, National Debtline can put you in touch with an independent financial adviser who will give you a free 30-minute advice session. It also produces a free booklet "Dealing with Debt". Call National Debtline on 0645 500 511 or contact your nearest Citizens' Advice Bureau.