The cheapest ways to borrow

by Neil Faulkner on 01 April 2009  |  3 comments
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We cut through the fees and charges of the various main ways to borrow in order to compare them properly.

APRs and fees can be misleading as they don't tell the whole picture. They can also be manipulated by the lender. That's why I'll give you some tips on the cheapest ways to borrow that see through the headline rates and charges.

Borrowing for absolutely nothing

The cheapest way to borrow, period, is to make purchases using a credit card offering 0% on purchases cards Provided you meet the minimum monthly repayments, pay off the card before the deal expires, and use it for nothing else (e.g. no balance transfers or cash withdrawals) you won't get caught out by any expensive traps. This method will then cost you absolutely nothing in interest or charges.

That was nice and simple. From now on, it gets a little more difficult.

> Compare 0% on purchases cards.

Borrowing for less than 4%

There are quite a few mortgage deals for less than 4% at present. For this reason, adding debt to your mortgage can be very cheap. It's only cheap though if you've got a competitive deal and you overpay on your mortgage with the intention of clearing the extra debt within a few years. (You should check first that you're allowed to overpay without paying a penalty.)

You also need to take into account any additional fees, but if you're remortgaging anyway then borrowing an extra sum shouldn't cost much more, if anything.

If you don't overpay and clear the extra debt, it'll linger for much longer than with an ordinary loan or credit card. Even if you have a competitive deal, and even though your monthly costs might seem low, the total interest you'll pay over that time will likely end up being far higher than most other forms of borrowing.

Remember, the more interest you pay in your lifetime, the less stuff you'll be able to buy throughout your life. Read: How to spend less and have more!

> You can compare mortgages through lovemoney.com's mortgage service.

Borrowing for less than 6% APR

Now it becomes even harder to compare, due to trickier charging structures.

The next cheapest way for most people will be to transfer debt to a credit card offering 0% on balance transfers. This is where it starts to get a bit more tricky to compare the costs, because these deals aren't really free. You have to pay a fee.

Typically the fee is 3%, but this doesn't mean 3% APR. It means 3% up front on your entire debt. Compare that with if you're charged interest at, say, 10% APR. The APR is the annual interest rate. So you won't pay 10% each month, you'll pay 0.8%.

As long as you're gradually reducing your debt, the interest you'll pay will go down each month, so you won't pay 10% on your entire debt. This is where APR differs from an upfront fee.

We can make these cards easier to compare by expressing the fees as an annual interest rate. If you pay a 3% fee, your deal lasts 12 months, and you pay off the whole debt in 12 equal instalments, it's the equivalent of 5.6% interest in the year. If you pay it off over six months, it's the equivalent of 10.7%.

If your debts are too big to pay off in a year, you could try to get successive deals. If you get two twelve-month deals in a row, both charging 3% fees, and you pay the debt off in 24 equal instalments, you'll still be paying the equivalent of 5.6% per year. That's a good rate of interest.

Again, when using balance-transfer deals, always pay at least the minimum and don't use the card for anything else, or you will likely be caught out by some expensive small print.

> The longest deals last 15 months with a 3% fee, which makes the equivalent annual interest rate even lower than 5.6%. See them in lovemoney.com's credit card section.

Interest rates of less than 10%

Next up is a combination of personal loans and long-term balance transfer-card deals. Both of these seem better than they are at first glance. The best of the personal loans are advertising rates around 8% APR and the long-term credit card deals are advertising around 7%.

The headline personal loan interest rates are misleading. Compulsory payment holidays on most loans add to the cost, so that they actually work out to be more like 9% to 12% per year. I explained how this works in Watch out for misleading 'Best Buy' loans.

You can still get one or two loans without compulsory payment holidays, such as Alliance & Leicester's 8% APR loan, which costs what it says.

> Compare personal loans with lovemoney.com.

Another way to get interest rates of less than 10%

As I just explained, the long-term card deals are currently advertising around 7% APR, but we must then add on fees. A fee of 3% is quite typical these days, but we can't just add 3% on to the APR to get the overall rate for the same reasons I outlined earlier in this article. If a card is offering you a deal of 6.9% APR plus a 3% fee, and you pay it off in equal instalments over 12 months, you'll pay the equivalent annual interest rate of 12.5%.

The good news is that if you're paying your debt off over two or three years, the effective rate will fall to more like 10%, because you've paid the fee just once. On the other hand, I would not advise you to spread out your repayments just to reduce the effective interest rate, as you'll pay less interest overall if you pay it off more quickly.

It's possible to get these sorts of cards with no fees. Typically, lifetime balance transfer cards which don't charge a fee cost 9% or 10% flat APR at present. I would expect that these deals are better for most people.

Compare credit cards at lovemoney.com