Don't get caught in a personal loan trap
Wednesday, 18 February 2009 11:43
While lenders have faced strong pressure from the government to lower their mortgage rates in line with Bank of England interest cuts, many customers taking out personal loans have been shocked to find their variable rates have been increasing - while some existing borrowers have also seen rates hiked.
As the number of borrowers struggling with repayments increases, Sarah Routledge investigates rising interest rates on personal loans.
The cost of an unsecured personal loan has jumped, in some cases by 3.4 per cent, in just 18 months, according to Moneyfacts.co.uk.
The comparison site found smaller loans have seen the biggest increases, with the average rate on a £1,000 loan today standing at 19.8 per cent, while the average rate on a £5,000 loan has jumped to 12 per cent.
"Base rate may be at a historically low level, but anyone needing a personal loan has seen no benefit," says Michelle Slade, analyst at Moneyfacts.co.uk.
"Rising unemployment and a declining economic outlook have meant the risk of customers defaulting on unsecured lending has increased. As a result, borrowers are paying a significantly increased rate than they were 18 months ago," Ms Slade explains.
Data from the Bank of England back this up, with banks reporting a rise in defaults on personal loans over the last three months of 2008.
Interest rates may rise even further following a ban on payment protection insurance (PPI), Ms Slade warns.
"As PPI used to subsidise lower loan rates, let's hope that as more providers follow suit, we don't see loan rates increasing further to cover lost revenue streams."
According to Moneyfacts research, 18 banks from a list of 24 lenders have increased their interest rate on personal loans since October 2008, despite the Bank of England cutting the base rate five times since then.
Variable interest rates rise
While it is getting more expensive to borrow with an unsecured loan, which are usually offered as a fixed rate, existing customers holding a secured personal loan with a variable interest rate are increasingly worried their repayments will become unaffordable.
Some customers of FirstPlus, a subsidiary of Barclays that offers secured loans, are concerned the lender has refused to clarify its policy on changing the interest rate.
Angus Doyle, founder of campaign site firstpluscomplaints.co.uk, says: "When the base rate first started dropping, people started noticing First Plus rates were going up. When we approached First Plus, we were given different answers about why it was going up."
Mr Doyle adds: "They say they calculate it on 'market conditions', which gives them an open license to take it up and up."
According to Mr Doyle, First Plus - which no longer lends to new customers - is preventing customers from leaving to take out a more competitive rate with "massive redemption charges".
"It's one of those situations where you are caught between the devil and the deep blue sea," he explains.
Mr Doyle says he understands that companies have to cover the cost of increased rates of defaults and operational costs, but the lack of clarity on how the increases are calculated is making it very difficult for customers to predict when the next increase could be.
If the costs of these loans continue to spiral, many consumers with a loan secured on their house will end up losing their home, Mr Doyle warns.
A spokesperson for FirstPlus says it was made clear when these loans were sold they were variable and it do not track Bank base rate.
"Our pricing is based on the market we are in, our costs and the security we hold and our prices are in line with, or better than, others offering similar products to similar customers.
"Current trading conditions mean that the security against which our loans have been made has and continues to deteriorate and our pricing reflects this fact, however two thirds of our customers are paying an interest rate of less than ten per cent and our prices remain competitive against those products currently available in the market," the firm says.
A spokesperson for the British Bankers' Association said it is not surprising that the interest rate on loans has not fallen in line with base rate changes, as the Bank of England base rate applies to overnight lending - not long-term inter-bank lending, which is governed by Libor.
Although long-term lending has therefore become more expensive, the BBA said it was not aware of many cases where existing borrowers were seeing their rates rise since base rates have dropped.
However, lenders can at any time increase the rate of interest they charge borrowers, potentially leaving many borrowers unable to afford their debt, provided this is written into the contract.
And excessive redemption penalties could mean the borrower has no way of getting out of this contract.
Loan rates investigated
Both the regulators and the industry are looking into how interest rates are calculated, the Office for Fair Trading (OFT) confirms.
The OFT says there must be scope for the interest rate to change - as it could go down as well as up - but it must be made clear to the consumer when and how these changes are made, so they are not done in an unfair way.
The regulator says it has concerns about the second-charge sector - particularly as defaulting on these debts could ultimately lead to repossession - and is looking into the issue as part of a project to clarify what is meant by 'irresponsible lending', in an attempt to get a fairer deal for borrowers.
The regulator is drafting new guidelines to address these issues. In a consultation paper, the OFT proposes: "There should be full transparency about the circumstances in which any variable rates or charges may change, in particular where they are not linked to Bank of England base rate and where they may be varied at the discretion of the lender.
"Rates should only be varied to recover genuine increased costs in lender funding and should not be misused, for example, to take advantage of a borrower's lack of ability to end the agreement. Full and true explanations should be given to borrowers when rates are varied."
Early repayment fees should be "fair and reasonable" the OFT adds.
Read the small print for protection
Some progress has already been made, at least in the credit card sector.
In December, business secretary Peter Mandelson held a meeting with credit card companies, where they agreed to give more warning to cardholders before hiking rates.
But there is only so much the government and regulators can do for borrowers who are feeling overstretched, according to Pierre Williams, head of research for moneyexpert.com.
"It is a problem - there has been over borrowing by consumers and over lending by banks. There is a lot of debt out there and it has to be paid," he says.
"Ultimately, some people will end up losing out."
But what can consumers do if they are concerned about being caught in a lending trap?
Understand what you are signing up to and make sure you are getting a competitive rate, Mr Williams advises.
"There has never been a better time for consumers to look at the rate they're getting," says Mr Williams.
"Lenders are trying to extract as much money as they can from borrowers, so you have to keep a constant eye on the best rates."
However, in order to move quickly to get the best rates you need to be flexible, Mr Williams adds.
"Read the small print carefully," he recommends.
"Be very careful about any tie-ins or fees you may have to pay. In these days, it is probably to your best advantage, even to the extent of paying a higher rate, in order to avoid being tied in."
If you are considering taking out a personal loan, it is very important to check the terms and conditions of the contract you are signing and if the rate is variable, consider whether you would still be able to afford the repayments if they were to increase.
And make sure when taking out a loan you know exactly what the fees and charges are in the event you want to pay it off, as high fees could prevent you from moving to a more competitive lender.
Sarah Routledge
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