Hidden penalties in personal loans

Banks are taking advantage of a loophole in credit law to advertise interest levels customers cannot obtain. They are highlighting annual percentage rates below 10 per cent on personal loans - unsecured borrowings used for home improvements, car purchase or consolidation of credit card bills.


But these low rates are available only if borrowers buy additional and expensive insurance products. In some cases, bundling unwanted or unnecessary cover can almost double loan costs.


The practice means bankers can gain an unfair advantage in best buy tables over lenders who do not force customers to buy unwanted policies. Forcing borrowers to buy insurance so they can have a discount on the loan itself is similar to the bundling of package holidays and insurance which has now been banned in the travel trade.


The practice has been slammed as "misleading" by a leading bank. It can unfairly discriminate against loan-seekers who are living on a pension or are self-employed. And it runs counter to Trade and Industry Secretary Stephen Byer's pledge this month that mortgage and credit lenders will be required to give clear, comparable information about products.


First Direct's marketing literature promises "A personal loan from 9.9 per cent APR" in large print. The rate is listed as available for sums between ?10,000 and ?15,000.


It sounds "tempting", to quote the First Direct pamphlet. But it is only when prospective borrowers get further into the small print that they will realise the 9.9 per cent rate does not really exist.


The only way First Direct customers can find a rate that low is to buy the bank's Repayment Protection Plan, which pays out if the borrower cannot keep up repayments due to losing income through redundancy or ill-health. And this can be costly.


A typical ?10,000 loan over three years at a 9.9 APR with insurance costs ?361.60 a month to repay. The same borrowing without insurance would be just ?322.20 a week - but it's not available. Over the loan period, the insurance costs ?1,418 - enough to fund around four and a half months' payments.


First Direct is not alone in quoting a rate that is possible only if customers buy expensive cover. Northern Rock highlights a 9.3 APR. This would cost the borrower wanting ?10,000 over three years ?319.40 a month.


But the only way the 9.3 per cent rate is available is if borrowers buy Northern Rock's payment protection plan, which brings the costs up to ?363.33 a month. Over the life of this loan, insurance costs ?1,581 - nearly five months' repayments. Yet despite the potential premium expense, Northern Rock will pay only for a maximum of 12 months if customers lose their jobs. Adding in the insurance premiums to the loan would create an effective 18.3 per cent interest level, almost twice the quoted rate.


The Co-operative Bank, which prides itself on its ethical stance, headlines "loans from only 9.9 per cent APR". It promises customers that there are "no arrangement fees, no security required". But it is only on the leaflet's third page that a "discount of up to 3 per cent off the standard APR" is mentioned - and even then prospective borrowers might think this is a further reduction.


Alliance & Leicester quotes "Personal loans from just 10.9APR" but again, this is available only if insurance is bought. A ?10,000 loan over three years costs ?362.62 with cover or ?329.14 without at a higher 11.9 APR. The A&L personal loan protection premium is ?1,285 over the life of the loan - nearly ?300 less than Northern Rock's - even though its unemployment cover lasts for up to 36 months. A & L interest rates fall by one per cent on April 1. Marks & Spencer also discounts insurance-based deals.


Tesco offers a 9.9 APR on a ?10,000 loan - but there is no need to take out insurance. The store's Shona Leisk says: "We don't believe customers should have to buy a policy. They should have a free choice." A ?10,000 Tesco loan over three years costs ?320.94 a month without insurance - ?359.32 with cover.


Direct Line's Stephen Geraghty says making insurance a compulsory part of the deal is legal. But he adds: "It is a cynical attempt to mislead customers. You can publish a rate which looks brilliant but is actually very expensive. You can't rely on APRs for guidance. It is not a level playing field."


Companies can quote low APRs by making two legally separate loans - one to cover the actual amount and the second to pay for the insurance policy - both of which comply with the low interest rate on the literature.


Geraghty says sickness and redundancy cover is a bad idea for pensioners or those who run their own businesses either as self-employed or as company directors, as they will rarely be able to claim. Direct Line has asked the DTI to change the rules on compulsory insurance cover.


First Direct Commercial Services Manager Nick Robshaw denies his plan is misleading. He says: "It's all there in the small print. Customers can see what they are paying for. The Consumer Credit Act does not include creditor insurance for APR calculations."


But Mr Robshaw admits that "there is an element of giving with one hand and taking away with another. Insurance is very profitable at the moment." Industry estimates suggest that only 40p in each pound of premium goes on claims. Most of the payouts go to those who lose their jobs.


He believes that legislation could soon close these loopholes: "I don't think our 9.9 per cent rate should appear in best buy tables. The market will start changing as both customers and legislators realise that creditor insurance does not offer value to everyone who takes a policy out."


But First Direct operatives are not trained to tell customers for whom insurance is poor deal that they would be better off without it. Loan experts say customers should ignore APRs and rely on monthly repayments to judge best value.