When borrowing more costs less
Borrowing a little extra with a personal loan could save you hundreds of pounds. We explain how.
In an ideal world you would never pay any interest on money you borrow. Luckily, this is exactly what 0% balance transfer credit cards allow you to do. But there’s a downside: the interest-free period is only ever temporary. The most generous cards offer a maximum of 16 months breathing space before the vastly higher typical APR kicks in.
If you need to borrow several thousands of pounds, 16 months might not give you the opportunity to fully repay your debt. In this case, you might decide a personal loan with fixed repayments over a pre-agreed term of your choice is a more suitable alternative.
Of course, you could keep shifting your debt from 0% card to 0% card until it’s completely paid off. But each time you transfer, you’ll likely need to pay a transfer fee of up to 3% of your balance. There’s also no guarantees you’ll be accepted for a new card next time round, and the interest-free periods may become shorter.
With all these unknowns, a personal loan may be a better fit. With that in mind, let’s take a look at how you can enjoy cheaper rates.
Personal loan rates are normally tiered with the highest interest rates charged on the smallest loans. Take the Sainsbury’s Finance as a classic example. If you wanted to borrow £3,000, the rate on the Sainsbury’s Finance Nectar Cardholder Personal Loan is a whopping 13.8%. But borrow £5,000 using exactly the same loan, and your rate drops like a stone to just 8.8%.
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Yes, of course lenders want to encourage you to take out larger loans by tempting you with far more attractive rates. But you can actually make this tiered system work to your advantage.
Make tiered rates work for you
For smaller loans, rates have increased steadily, while for larger loans rates are beginning to come down across the board. By exploiting this pricing anomaly you can pay significantly less for your debt.
It sounds crazy but in some cases, if you borrow £50 more than you need to, you may actually be able to save hundreds of pounds in interest over the term of the loan. Let’s use the Sainsbury’s loan again to see how this could work in practice.
But.... before we do that, let’s have a quick chat about eligibility. It’s true the Sainsbury’s loan is only open to shoppers with a Nectar Card. But this is no great hurdle since you can easily meet this criterion by applying for a card online here. Remember, you’ll need to use your Nectar Card at least once in store to qualify for the offer. Sainsbury’s may check your Nectar account to verify this - so be warned.
Now that’s dealt with, let’s get back to the figures. In this example, you apply for a loan of £4,950. Sainsbury’s charge a rate of 13.8% which means your month repayments are £166.78, and the total amount repayable over 36 months is £6,004.08.
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However, if you borrow just £50 extra, taking your loan up to £5,000, the rate falls to 8.8%. This time your repayments drop to £157.75 a month, and the total repaid for the loan is just £5,679.
So, bizarrely, by borrowing more your loan actually costs significantly less. In fact, by borrowing £5,000, instead of £4,950, you would save you a massive £325.08 in interest and you would of course also have the extra £50 you borrowed in your pocket, making you a total of £375.08 better off.
Clearly, there are big savings to be made if you’re a bit savvy.
As it happens, the Sainsbury’s Finance Nectar Cardholder Personal Loan offers the best-buy rate for borrowers who are looking for a £5,000 loan over three years, along with the Alliance & Leicester Personal Loan which also charges the same rate of 8.8% to new and existing customers. But neither lender provides the lowest-rate deal for loans of less than £5,000. For that you’ll need to look beyond the traditional personal loans market.
Is Zopa cheaper?
With that in mind, let’s see if this tiered rate trick still works if you chose the most competitive loan from peer-to-peer lending business, Zopa instead.
For those of you who haven't yet heard of Zopa, it's a novel social lending website that enables savers to lend to borrowers at rates which are not only capable of beating the banks, but cut them out of the saving/lending loop altogether. You can find out more about Zopa by watching this video.
Ed Bowsher takes a look at Zopa, an interesting alternative to the high street banks
If you borrowed £4,950 via Zopa, you could get a much lower rate of 9.3% (depending on your creditworthiness). Remember, the banks will charge you 13.8% for this.
This time your monthly repayments are reduced to £157.24, and the total amount you repay over the 36-month term runs to £5,660.64
The total amount you pay back with a £5,000 Sainsbury’s loan is £5,679, but given that you also have an extra £50 by borrowing slightly more, you’re still £31.64 better off for taking out a larger loan compared with the market-leading Zopa loan. If, however, you are borrowing less than £4,950, this may not be the case - so consider both options and do the maths before you decide.