From Money Magazine, October 2006
Paris? New York? Tahiti? If you're thinking about taking an overseas trip but haven't saved up the cash and don't want to wait to get the money together, a personal loan is probably the best way to finance your holiday. Another increasingly popular use of personal loans is debt consolidation, says Rod Hyde, head of consumer finance with HSBC.
The great thing about personal loans, unlike credit cards, is that they're ideal for people who find it hard to resist the temptation of access to credit. With a personal loan you borrow one amount, generally between $5000 and $40,000, and you're required to pay it off within a set period, usually ranging from one to seven years.
In comparing personal loans, the interest rate will be a major deciding factor. Some of the most competitive rates are offered by credit unions and building societies. Rates currently start at around 7.7 percent and most major banks charge rates closer to 13 percent for unsecured personal loans.
"A percentage difference may not seem like much, but it can make a big difference in the monthly repayments and the interest bill overall," says Anthony Sexton from Cannex. "A lot of times you'll be given a rate range. Find out exactly what you're paying."
You will also have the opportunity of choosing between a fixed or variable rate.
The bonus with a fixed-rate loan is that this makes it easier to budget because you know exactly what your repayments will be. With a variable rate your repayments can rise if rates go up (or fall if rates fall).
Think about your financial situation and whether you could afford to pay higher repayments if rates go up. The advantage of variable-rate loans over fixed-rate loans is that they tend to be more flexible.
Another factor that influences the interest rate is whether the loan is secured or unsecured. With a secured loan, the lender takes security over an asset worth more than the loan, so that if you default on the loan they can sell the asset to cover the repayments.
"The advantage of a secured loan is that you get a better rate," says HSBC's Hyde. "However, there is a fair bit of paperwork and it takes longer to get approval." Secured loans are usually used to finance the purchase of a car.
Unsecured loans are more common and, because there's no collateral, tend to have a higher rate. Keep in mind that an "unsecured" loan doesn't mean the lender will write it off as a bad debt if you fail to make repayments. They are still likely to pursue you for the money.
Most loans also have an establishment fee, which can be as high as $200. And some loans also have ongoing fees, charged monthly or annually.
Trevor Barbeler, of the Heritage Building Society says, "There are plenty of loans out there that don't charge fees, so shop around."
The best way to get a clearer picture of the cost is to look at the "comparison rate" or true rate. This takes into account any annual and ongoing fees as well as the interest rate. It can indicate to you a cheaper loan even if the annual rate is more expensive.
You might also be interested in flexibility. Key questions to ask include whether you can make higher repayments or pay a lump sum without incurring a penalty fee.
Pay as much as you can
Making extra repayments is in your interest because this will shorten the term of the loan and can save you interest. Some loans allow you to redraw if you've made extra repayments and are ahead, says Barbeler. If you're ahead in your payments you may be able to stop them for a while if you get into any trouble, he adds.
As with any financial product, it's vital to shop around. "Don't just accept the first rate you see," says Mark Franzmann, head of marketing with Bank of Queensland. Haggle if you can for example, the establishment fee might be negotiable.
If there's no security involved, most applications can be approved within 24 hours, so it's a fairly easy process.
Be careful about making too many applications though these all appear on your credit file and can make you look desperate. If you get knocked back by one institution, try to find out why before applying to another company.
For the complete story see Money Magazine's October 2006 issue. Subscribe now.
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