Where to open the door to the cheapest personal loans

Rates for borrowing have reached a new record low. But a lot depends on just how much cash you need.

Check out all your options before deciding how best to borrow money. Photograph: H Armstrong Roberts/ClassicStoc/Getty Images

Personal loan rates reached a new low of 3.5% this week after Sainsbury’s became the latest lender to cut the cost. The supermarket shaved 0.1% off borrowing £7,500 to £15,000 for up to three years for Nectar cardholders. This undercuts its closest rivals Cahoot, First Direct, Nationwide and M&S Bank, which are all offering similar-sized loans at 3.6% APR.

The move comes less than a month after the Bank of England said rates on personal loans had reached the lowest levels since records began.

“This is being driven by ferocious competition for the best borrowers from peer-to-peer lenders,” says Neil Faulkner, founder of peer-to-peer lending comparison site 4thway.co.uk.

The direction of the market could be about to change, however, according to Andrew Hagger of Moneycomms.co.uk. He says: “Lenders are just tinkering by cutting the odd 0.1% here and there. I think we are very close to bottoming out, as rumblings about a base rate increase start to get louder.”

In other words, now could be the time to act if you do need some cash. So where will you find the cheapest rate?

Less than £5,000

If you think you’ll be able to repay your debt within two years a 0% credit card is likely to be a cheaper and more flexible route than a loan.

Not only is your borrowing interest-free, but you can make smaller monthly payments on a credit card and there are no penalties if you repay your debt early, unlike with a loan.

The current market-leading card, the Matched credit card from the Post Office, allows you to borrow at 0% interest for 25 months, before reverting to a typical 18.9% APR. However, we did a “soft credit search” to assess the chances of successfully getting the card, using the “credit card eligibility calculator” on moneysavingexpert.com.

We found there was only a 70% chance of being accepted – even when we tested an applicant who is employed full time with a clean credit record, earning a £100,000 salary.

Meanwhile, Virgin Money’s All Round credit card – which offers 0% on purchases for 24 months – had a 95% approval rate for the same applicant. It also had an 80% approval rate for applicant with an equally clean credit record on a £25,000 salary.

You won’t be able to tell how much you’ll be able to borrow on a credit card before you apply, and only the most credit-worthy and affluent are likely to be offered a limit as high as £5,000.

Keep your credit record squeaky clean: if you don’t repay your balance before the interest-free period expires, you will need to apply for a new 0% card. You’ll then have to pay a balance transfer fee, typically 3% of the outstanding balance.

Need to borrow cash? A few 0% card providers, such as MBNA, Barclaycard and Virgin Money, allow you to pay money into your current account from the card. This “money transfer” does, however, incur a fee.

MBNA Platinum is the cheapest, at 1.99% on money transfers over two years, and 2.99% over three years. This means you could transfer £3,000 from the card to your bank account. As long as you pay it back within three years it would only cost £90. Compare this with Barclays – if you took out a £3,000 personal loan over three years you would pay 22.9% APR, that’s £1,058 .

£5,000 to £15,000

Peer-to-peer lender Zopa and Japanese bank Hitachi are market leaders, quoting a typical APR of 4.4% on personal loans over five years. This means it would cost you £572 to borrow £5,000 and £847 for £7,400.

If you want more – between £7,500 and £15,000 – the rate drops dramatically. Market leader here is Sainsbury’s, which now offers a typical APR of 3.5% if you hold a Nectar card (it’s free to take one out). The maximum term for this rate is three years.

If you need to borrow over a longer period, Sainsbury’s, Cahoot, Nationwide, First Direct and M&S Bank all offer five-year loans at a typical APR of 3.6%. £7,500 over five years at this rate would cost £694, while £10,000 would be £926.

Eagle-eyed readers will have spotted that borrowing £7,400 at 4.4% will cost £847, while £7,500 at 3.6% will be just £694. This is due to competitiveness in the £7,500 to £15,000 bracket.

You can make overpayments on a Sainsbury’s loan without incurring any penalties​​. You will end up paying it off early, shortening the term and reducing the overall cost. Your monthly repayments will, however, be larger than if you had borrowed a smaller amount.

More than £15,000

At this level, some householders will consider approaching their mortgage provider and borrowing against their home. But you are putting your home at risk. You also face greater upfront costs because mortgage lenders charge arrangement and booking fees which loan providers do not.

Although there are fewer lenders willing to go above £15,000, rates are still competitive.

For example, First Direct will lend up to £25,000 at 3.6% typical APR over a maximum of seven years to its current account holders. This would cost £337 a month. The total charge would be £3,301.

By contrast, adding a £25,000 loan to an existing mortgage on a variable rate of, say, 2.5% with 15 years remaining would be just £167 a month. However, you’ll end up paying £5,006 in interest, plus any applicable upfront fees.

It may also be more difficult to increase the size of your mortgage than you expect. New rules which came into force last year require lenders to carry out a “stress test” on how you manage repayments if interest rates rise.

“Anyone with an interest-only mortgage may find it difficult to increase it without converting to repayment,” says Ray Boulger of broker John Charcol.