There are numerous reasons why you might look to take out a loan, including investment, debt consolidation and a means to pay off debt attracting higher interest rates.
Unfortunately, the vast majority of people tend not to consider refinancing on lower rates despite the significant financial benefits. In the long term, this can lead to interest payments which could have been reduced or avoided.
Since the 2008 US mortgage crisis, UK base rates have been around their historic low with the coronavirus pandemic pushing rates lower. It is impossible to say how long UK base rates will remain at current levels, but there is definitely renewed interest in refinancing debt.
On the flip side of the coin, as UK bank savings rates are negligible, it does, in theory, make more sense to pay off debt, attracting higher interest rates, rather than building up your savings.
Prior to taking an in-depth look at some of the more common uses for personal loans, we will take a look at interest rates versus APR.
Interest Rates Versus APR (Annual Percentage Rate)
When looking at any form of debt, you will likely come across two different rates which are the interest rate and APR rate. The interest rate is the rate at which interest is charged on the principal loan amount.
You might be forgiven for assuming that the interest rate and APR rates should be the same. Not always. You will often find that debt arrangement will attract additional charges such as for example, a set-up fee.
In many cases, this fee, and any additional fees, are added to the principal loan amount on which interest is also paid. So, the APR rate is the “true rate” as it reflects any additional charges connected to a loan.
So, when comparing and contrasting loan/debt arrangements, you should focus on the APR rate as opposed to the headline interest rate. That way, you are comparing on a like-for-like basis, including any additional charges.
When considering affordability, you may also be interested to see the breakdown of average household weekly spending supplied by the Office for National Statistics: –
|Expenditure||Value||% Household Income|
|Housing, Fuel and power||£79.40||13.5%|
|Recreation and culture||£76.90||13.1%|
|Food and non-alcoholic drinks||£61.90||10.6%|
|Restaurants and hotels||£51.30||8.8%|
|Misc goods and services||£45.50||7.8%|
|Household goods and services||£40.80||7.0%|
|Clothing and footwear||£24.40||4.2%|
|Alcoholic drinks, tobacco and narcotics||£13.00||2.2%|
The above statistics will give you an idea of average household expenditure and how much may be left over to cover loan repayments.
Getting a Loan to Pay Off Debt
Over the years it is relatively easy to accumulate a number of relatively small loans which will require monthly repayments (sometimes minimum monthly payments). Depending upon the type of debt taken out, your personal circumstances and the level of funding required, interest rates can vary wildly.
Therefore the idea of getting a loan to pay off existing debt can be very useful in the longer term.
We will now take a look at some of the reasons why you may want to secure a new loan to pay off debt: –
As we touched on above, debt consolidation is a very popular option for those with multiple loans, perhaps attracting relatively high-interest charges.
The idea is simple, work out how much debt you have accumulated, take out a loan whereby the principle amount will cover the outstanding debts and repay the debts.
Extended Repayment Terms
As the cost of living continues to rise, with wages often lagging behind, it can be difficult to budget for all expenditure. As a consequence, using a loan to pay off debt may give you the opportunity to extend repayment terms which will bring down the monthly repayments and hence leave more disposable income.
While you will obviously pay more interest because you are paying the loan off over an extended period, this can assist with short-term cash flow.
There is nothing stopping you from making additional repayments, if you have surplus cash in the future, above and beyond your contractual figure.
The Advantage of Lower Interest Rates
Since the 2008 US-led mortgage crash, worldwide base rates have remained at relatively low levels. As a consequence, those who signed up to debt arrangements prior to the crash may be locked into interest charges much higher than those available today.
As a consequence, it may well be possible to refinance existing debt, even consolidate debts, at a lower interest rate. This means that a larger percentage of repayments are used to pay down the principal debt with the balance used to cover the interest.
Therefore, as the principal debt falls, so the interest charge is reduced, and more capital is paid towards the initial loan.
Compare and Contrast Debt Funding
As you will see from the chart below, a reduction in loan interest rates/loan terms can have a significant impact on your monthly repayment charge and overall interest paid.
|Initial Loan||Loan Term||Interest Rate||Monthly Repayment||Total Interest paid|
You may well ask the question, why would you extend the loan term and pay such an increase in interest?
Well, at the time an individual may have issues with cash flow; therefore, smaller monthly payments spread over an extended time period might be a better fit for their budget.
One of the problems to consider is the possibility that those who struggle to cover monthly loan repayments may end up accumulating additional debt with overdrafts, credit cards, etc. on even higher interest rates – and the debt issue starts all over again.
Therefore it may be more beneficial to refinance a loan and extended the duration.
Getting a Loan to Pay Off a Car Balance
There are numerous ways in which you can purchase a vehicle.
These include: –
- Cash payment (may include a part exchange)
- Personal loan
- Car finance
- Personal Contract Purchase (PCP)
When it comes to personal loans, car finance or PCP, there are numerous different issues to take into consideration. For example, if you are buying a car with a personal loan, then the vehicle is yours from day one.
When looking at car finance, this will be secured on the vehicle which will not legally be yours until all of the funds owed have been repaid. If you miss repayments, the vehicle can be sold to raise funds outstanding.
If there were additional funds left these will be sent to you but if there was a shortfall, then you would be expected to cover any balance.
The subject of PCP can be quite complicated because while there are similarities to hire purchase, it isn’t quite the same.
At the end of the contract, you will have the option to: –
- Return the car
- Pay the reseller value and purchase the vehicle outright
- Use the reseller value towards a new vehicle
So, while there may be interest rate benefits when securing a loan to pay off a car balance, you will also be able to take ownership of the vehicle.
PCP contracts can be relatively complicated and often include a minimum resale value as a means of offering a degree of protection to the customer.
However, it is very important that you fully understand what you are signing up for and your legal obligations.
Getting a Loan to Buy a New Car
When you consider that a new vehicle can cost upwards of £10,000 and a second-hand vehicle well into the thousands of pounds, it is no surprise that many people take out personal loans/car loans to buy a new vehicle.
There are some issues to consider with regards to personal loans and car loans such as:-
- You may be able to negotiate a discount if paying “in cash” even if the cash was raised from a personal loan
- Car loans direct with a dealer can be relatively expensive compared to personal loans, and there may be additional obligations such as servicing, repairs, etc
- You will own the vehicle from day one with a personal loan
- The finance company will own vehicles acquired through a car loan until the debt has been repaid in full
As with any type of finance, it is very important to consider not only the headline interest rates but also potential add-ons and additional liabilities/obligations.
For example, as we mentioned above, under a car loan, you may be obliged to service your vehicle with the dealership, which can be significantly more expensive than an independent garage.
What might seem like relatively small add-ons for car finance can very quickly accumulate into significant additional liabilities.
Getting a Loan to Pay Off Credit Card
While often very useful to have on your person, credit card debt is one of the biggest problems in the UK.
When you consider that double-digit interest rates are the norm with extremely high rates charged for those with “chequered credit history” it is fairly easy to become dependent on credit card finance.
If you compare double-digit credit card interest rates and additional charges for late payments, etc. it makes perfect sense to look at a personal loan to consolidate and repay credit card debts.
It is probably easiest to demonstrate the impact of higher credit card interest rates with some examples: –
|Type of Debt||Principle Amount||Term/Repayment Period||Interest Rate||Monthly Repayment||Total Interest Paid|
|Credit Card||£2000||4 years 7 months||15%||£50||£714|
|Credit Card||£2000||5 years 3 months||20%||£50||£1119|
As you can see, with a monthly repayment of £50 not only is the debt repaid quicker with a personal loan but you also pay less interest.
In the current environment, it may also be possible to negotiate a personal loan with an interest rate of less than 9.9%, thereby reducing the repayment period and interest paid.
It is only when you see the facts and figures in front of you that the issue of accumulated interest begins to standout.
Many people struggling with their credit card debt, perhaps missing the odd payment here and there, can leave it too late to refinance with a personal loan.
If they have missed numerous credit card payments, and perhaps other debt repayments, this may be added to their credit file.
As a consequence, some financial institutions may refuse loan applications, or recent financial difficulties could lead to a higher interest charge.
If you are struggling to cover your contractual repayments, you should seek professional financial advice as soon as possible.
Pay Off Overdraft
The vast majority of consumers in the UK will, at some point likely be offered an overdraft on their banking facility. In many cases, there will be a “free buffer” upon which no interest is paid although in some cases there may be a relatively small monthly charge.
Unfortunately, it can be tempting to consider your overdraft as part of your “funds available” and very quickly you can become dependent upon it for your budgeting.
This is all good and well, but once you extend past the free overdraft level, you will be hit by significantly interest charges. These rates can vary from low double digits to above and beyond 30%.
You will often see overdraft interest rates quoted as “EAR” which stands for Equivalent Annual Rate, which is effectively the annual interest charge on overdrawn funds. It is also worth noting that the way in which overdrafts interest charges are calculated can vary.
Some banks will charge them on a monthly basis while others will charge a daily fee for each day you are overdrawn. While the daily charge figures published by the banks may look relatively small, they can be significant when quoted on an annualised basis. Be wary!
As a consequence, many people will choose to replace an expensive overdraft with a less expensive personal loan. There are two benefits to this, it adds a degree of structure to long-term repayment plans, and it also replaces relatively expensive debt with lower interest charges.
If you are repaying an overdraft with a personal loan, it is advisable to consider terminating your overdraft agreement to remove any temptation.
Pay Off Another Loan
In the current relatively low-interest-rate environment, it makes sense to consider fixed or variable loan interest rates from years gone by against those achievable today.
While dependent upon your specific credit rating, it may well be possible to secure funding on a lower interest rate to pay off higher-rate debt. You will often see financial institutions quoting reduced headline interest rates, the more funds you lend.
As a consequence, there may be some room to consolidate additional debts under one loan and thereby achieve an improved headline interest rate.
At this point, it is also worth considering the duration of the loan agreement and what kind of monthly repayment you can afford.
If you work backwards from the level of repayments, you can afford and the funds required to pay off other debts you will able to work out the optimum term.
There is no point securing additional finance to pay off another loan if this will stretch your budget and leave you open to additional pressures going forward.
Home Improvement Loan
Many people strive to create their dream home and as a consequence home improvement loans are very popular. The idea is simple; use the loan money to fund improvements to your property which will increase the value of your home by more than the cost of the loan.
The range of funding required can vary from just a few thousand pounds to tens of thousands of pounds and beyond.
It obviously depends upon the type and cost of improvements to be made, but for many people, it can be a lucrative investment.
There are a number of issues to consider when looking at home improvement loans such as: –
Potential Increase in Property Value
When looking at a loan for home improvements, this should be considered akin to an investment. If you invest £10,000, then you would hope to gain a valuation uplift of say £15,000 upwards.
That way you know that the cost of your loan, including interest, has been worth it in the longer term.
No matter how attractive the potential improvement in your property may look from a distance, and the investment makes perfect sense, you need to be able to afford the loan repayments.
If this was to push you towards significant financial difficulties, then the repercussions could be huge.
One interesting element of the property market revolves around what is known as “glass ceilings” with regards to property prices.
If property prices in your area tend not to exceed, for example, £200,000, and your property is already worth in that region, then there may be little benefit in investing £40,000 in home improvements.
Even if you were to break through that £200,000 “glass ceiling” it is unlikely that you would recoup all of your investment – at least in the short-term.
So, when looking at home improvement loans, you need to appreciate your own specific financial scenario and the potential uplift in your property value.
On a positive note, if you were to see a significant uplift in the value of your property, then you may be able to remortgage and release further equity.
Whether looking at a property, business, stocks and shares or a valuable antique, from time to time, you may well be presented with attractive investment opportunities.
The chances are at the time you may not be as cash liquid as you had perhaps hoped and therefore you may require a short-term investment loan.
There is a risk associated with any investment, and it would be foolish to assume otherwise – hence the risk/reward factor.
However, there are ways and means of facilitating investment loans such as:-
The interest rate associated with any loan is a reflection of the risk/reward ratio from a lender’s point of view. In simple terms, the higher the risk, the higher the interest rate to compensate for this increased risk.
On the flip side, with a relatively low-risk loan perhaps backed by collateral, the lower the headline interest rate.
So, if you have assets available, you may be able to use these as collateral to secure funding.
Experience Is Priceless
If you have a track record, for example in property and are presented with attractive property investment, then you would likely have a greater chance of securing an investment loan compared to someone without that experience.
While experience is not a guarantee of success in the future, it demonstrates to the lender that you have been there, done it and you have the experience to do it all again potentially.
If you have a viable exit route for an investment loan, then you will probably have a good chance of securing funding.
For example, you may have the opportunity to buy a property well below the market price, which requires little in the way of additional work to bring it back to an acceptable living standard.
Therefore, there may be the opportunity to refinance an investment loan into a traditional long-term mortgage while possibly extracting additional equity.
Bridging loans are commonly used with a property when individuals/families are caught in between the sale of an old property and the purchase of a new one.
They are also commonly used when acquiring property at an auction where a quick settlement is required. The idea is simple; the bridging loan will be secured against the property and eventually converted into a traditional mortgage at which point the bridging loan will be paid off.
Bridging loans tend to attract a higher interest rate than traditional property loans and can vary in length from just a few days to between 12 and 18 months.
You will also find that the interest on bridging loans tends to be rolled up, therefore, assisting those who may have cash flow problems in the short-term but money to come/asset sales further down the line.
However, be wary of the cumulative interest charge and the interest on interest. We have written extensively about Bridging loans here, ‘Our Guide to Understanding a Bridging Loan‘ which covers all the main bridging loan information.
In the current environment, many people are finding they can refinance existing debt, consolidate loans and create a repayment structure which bests suit their current situation.
There is also the option to extend loan terms as a means of reducing monthly repayments in the short-term and assisting cash flow. When you look at the interest rate on credit cards and overdrafts as two examples, the option to refinance on a fraction of the rate has attractions for many people.
However, don’t forget there will always be an affordability calculation to ensure that repayments can be honoured going forward. Indeed, when we remove the various factors associated with loans, it comes down to a simple risk/reward ratio.
The interest rate on any loan will reflect the risk that the borrower will be unable to afford repayments going forward as well as underlying base/interest rates.
As we touched on above, the use of collateral acts like an insurance policy for lenders and therefore should help soften the headline interest rate.
How Can Flexy Loans Help?
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They have already helped thousands of people get loans already, and they can do the same for you.
Choosing a loan broker like us (we don’t charge any fees) means our application process matches you with the best loan available to you. All lenders we recommend are regulated by the FCA, which gives you an additional layer of protection.
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