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Getting Credit – What to watch out for

Introduction

The starting point to understanding any credit deal is that whoever offers it is out to make money – as much of it as they can – from you. And not all of the ways in which they do so are obvious to spot.

If you are applying for a credit card or a loan, here are some things to ask about.

Loans - The Annual Percentage Rate (APR)

An APR is, in theory, the annual rate of interest you should be paying on your loan. Generally, the lower the APR, the lower the cost of your loan.

But things are not always that simple. Lenders and credit card issuers have considerable leeway in deciding how they apply their APR, for example by using different time frames to calculate it.

Ask the prospective loan provider to tell you the monthly repayments over a given period – and how much interest you will be expected to pay.

Redemption fees

Borrowers who want to pay off their loans early often face redemption penalties of up to one month’s interest.

Moreover, different lenders operate various rules. Most will insist that the interest penalty is the same regardless of either the amount repaid or the period still left.

So if you take out a three-year loan, the interest penalty is the same regardless of whether it is paid one month into the loan, or one month before it was due to run its course.

Not all lenders do this. So always ask how much the redemption fee is – and how they calculate it.

Rule of 78

This was a bizarre charge that used to be applied, IN ADDITION to the redemption penalty.

The term itself originally came from totalling up the first 12 numbers of a 12-month loan. So, for example, 1 plus 2 plus 3 plus 4 plus 5... and so on adds up to 78.

Lenders would ALSO levy any interest – on a reducing scale – that was still payable over the remainder of the loan.

However, since 2005 this rule no longer applies. Changes to the Consumer Credit Act have been made to ensure consumers get a fairer deal:

• The lender cannot charge more than 28 days penalty interest on a loan that is being repaid early
• Lenders must now calculate the actual amount of saving a customer makes by repaying early
• When customers take out the loan they must be shown the amount payable at quarter, half and three quarters of the way through the loan. This can be the exact figure or a representative amount based on how much per £100 or £1,000. Be sure to find out how much this might be

Loan insurance

Often, if you ask for a quote on a loan, the lender will automatically add on the monthly cost of loan protection, so-called PPI cover.

Many lenders won’t even tell you they are doing this. So if you sign on the dotted line, you may end up with cover you do not want or need.

It gets worse. Not only is PPI cover expensive, but many lenders add the full cost of the insurance itself to the loan at the outset, leaving customers to pay interest on the cover AS WELL AS the sum they borrow. This is why it can add up to 30 per cent to the cost of the loan.

If you redeem a loan early, you could end up paying both an interest penalty not just on the loan itself, but also on the cost of the PPI cover as well.

If you really need protection, it can make far more sense to buy the cover separately from an independent broker. It is not only cheaper, but you face a smaller redemption penalty.

If you are repaying your loan early and PPI was sold as part of that loan, then its cost must also be factored into any early repayment quote. If it was sold as a separate contract then it must be calculated separately.

More pages

Page 1: Introduction
Page 2: Daily or monthly interest?
Page 3: Using your credit card abroad

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