Personal Loans : What the lender wont't tell you

A staggering 16 million people, over a third of the UK adult population, are unaware that the majority of personal loan providers levy penalties on borrowers who repay their debt early, according to new research from Intelligent Finance (IF), an online bank.

With interest rates at historically low levels an increasing number of people are being lured by the attractive loan rates currently available. You can borrow £5,000 for as little as 6.3%. But many of those lucky enough to be in a position to repay their debt early are being charged for doing so. IF estimates that this is costing consumers about £336m a year.

Nearly 75% of personal loans charge early redemption penalties yet many providers are guilty of burying this fact in the small print of the terms and conditions. IF, which does not penalise you for repaying a loan early, is calling for those that do to make their charges more transparent.

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Grenville Turner, chief executive at IF, says: “If you think these charges are so reasonable, stop hiding them in the small print and be more upfront with borrowers about the costs of early repayment.

”In addition to the lack of transparency another concerning factor about these redemption penalties is the way in which they are calculated. The Department of Trade and Industry (DTI)

recently announced that plans to reform the 30-year old Consumer Credit Act, and this is one of the areas it will focus on.

Most personal loan companies calculate the total amount you pay over the term of a loan using a scheme called Rule 78. This tends to stagger interest unevenly so that in the early stages of the loan a higher proportion of the repayments are made up of interest, leaving you with a larger amount of capital outstanding. Most also calculate redemption penalties in the same way, making it virtually impossible for consumers to understand how an early settlement figure is arrived at. Research from online bank Egg found that the majority of lenders that levy penalties charge about two month’s interest.

Whilst the DTI’s proposals will not ban companies from charging redemption penalties, they will only be able to charge one month’s interest. However, a number of personal loan providers do not levy any fee for repaying your debt early, so if you think you may be in a position to do so it is worth considering taking out one of these loans. In addition to IF and Egg, other companies that offer loans penalty free include Virgin, Cahoot, Nationwide, Woolwich, Barclayloan and Morgan Stanley.

You do need to look at the rate of interest however, as it may still work out cheaper to go for a lower rate even though you will face redemption penalties for paying the debt off early. Check the details of the terms and conditions though as there is no correlation between the rate of interest charged and whether that lender levies redemption penalties. For example, HSBC has an interest rate of 13.9% on a £5,000 standard loan but it also charges those who clear the debt early. Yet, Northern Rock is offering a penalty free loan, the rate for which is only 6.3% if you borrow £5,000