The headline rate is the best tool a lender has for selling its loans. It’s what gets them to the top of the best buy tables and comparison sites and that’s what gets them customers.
But there have been calls for lenders to be more honest about the price of their products, with suggestions that lenders are using hidden charges to rack up the cost of the debt.
After all, the real price depends on how you use the loan. Most lenders charge fees when loan repayments late and fees when the debt is cleared early. Some then also attempt to up-sell or cross-sell further financial products.
How the charges stack up
It’s very difficult to get information from lenders on their various charges – especially on a comparison table. However, research from Amigo Loans shows how much a loan from one high street lender, Halifax, could cost once a few additional charges had been factored in.
For example, imagine a borrower who takes out a five-year loan for £2,500 to fund a business. Because the loan is comparatively small, they could be offered a headline APR of 29.9% - more if their credit score is less than perfect.
Because of supplier issues, two loan payments are late. Then a large contract means the loan can be paid off after just one year.
Repayments for such a year would total £906.12. Add in £61.77 in late payment fees and 58 days interest for paying the loan off early and that’s an extra £162.47. That’s 42.7% of the loan amount.
But none of this is clear when comparing loan rates.
“Banks and lenders just expect to make the majority of their income from other charges,” said Amigo Loans chief executive James Benamor.
“Either from cross selling, like the PPI scandal, or from additional charges. It’s the charges that seem most unfair, people who are in trouble effectively subsidise the people who are able to make the repayments.”
Why the headline rate ain’t all that
Many people are disappointed to find out that while they are free to apply for a best-buy loan, they then get offered a worse rate. The lender has to prove that most of its successful applicants get the typical rate, but can charge far more to other borrowers or simply reject them outright.
The trouble is that by that point the would-be borrower has had a credit search made on their account, and might struggle to qualify for further loans. That’s because a credit search can temporarily depress your credit score, making it harder to qualify elsewhere.
Because of that, borrowers can feel they have to accept whatever rate they’re offered. So that’s another way many people can be pressured into paying more than they thought.
Options to beat the hidden charges
So where can you turn if your loan application is rejected? Or what if you simply want a bit more transparency over costs and flexibility about the repayment schedule?
If you have a perfect credit score you may be able to qualify for a market-leading rate as low as 5.6%. It would take an awful lot of charges before that works out cheaper than a loan costing 49%.
But if you have a shaky credit history, then a loan with a higher APR with no hidden charges could be a better bet. It could also allow you to borrow without turning to a doorstep lender or payday loan.
Credit unions sometimes charge an APR as high as 26.8%, but again, there are no hidden charges and no penalties for early repayment.
You can read more about them in our article Credit unions: Banking without the bankers
Not only that, but unions build life insurance into their loans at no extra cost to you, meaning that if you died while the loan was still outstanding, it would be repaid by the insurance.
So, you’re able to repay early if you want without being hit by an additional charge. You can also save with credit unions. Find a credit union you can join by visiting Find Your Credit Union.