News & Features

Be aware of hidden costs when taking out a loan

Borrowers should look out for early redemption penalties and other costs with taking out a personal loan. According to market research firm Datamonitor, 70% of loans are repaid early. However the majority of lenders charge a sizeable early repayment fee, which is usually around two months' interest.

Borrowers should be particularly wary of loans where redemption penalties are calculated according to the "Rule of 78". This allows lenders to skew payments so that the bulk of the interest is repaid before the bulk of the capital. This means that customers who pay off a loan early will still have a sizeable chunk of capital to repay and will have made disproportionately high interest payments.

Fortunately the new Credit Act will outlaw this and will limit the maximum early redemption penalty to just one month's interest.

Some providers do not charge early redemption penalities including Egg, Nationwide, Northern Rock, the Post Office, Virgin Money and Woolwich.

Borrowers should also look out for the costs of Payment Protection Insurance (PPI). This covers loan repayments if the borrower suffers from sickness, has an accident, or is made redundant. Lenders are keen to push these policies because they earn significant commission on each policy sold.

PPI can be very expensive and could add £2,000 to the cost of a £7,500 loan.

Borrowers should always check whether their repayment costs include PPI, and think very carefully about whether they really need it.

As always borrowers should study the PPI policy small print carefully as most have a number of exclusions. For instance the self employed, those employed under contract and people with existing medical conditions are unlikely to be covered under standard policy terms.