Your Money: How low could they go?

A FIRE sale seems to be blazing on the personal loans front, with Egg cutting its interest rate further this week. But borrowers would do well to study the details of the latest bargain basement offers, because these sexy rates are not always what they seem.

Unsecured loans are a popular way of paying for a new car, home improvements, holidays or weddings, because the monthly repayment is fixed at the outset, making budgeting easy. Traditionally they were more expensive than an overdraft, but in recent months a flurry of new-style loans from Egg, Northern Rock and the Woolwich, plus intense competition from other lenders, has pushed prices down.

But borrowers should beware, because some of the cheapest deals around are conditional on buying an often expensive payment-protection insurance policy, which pushes up the monthly cost sharply. If borrowers decline this cover, then they must pay a higher rate of interest.

Northern Rock, which has a headline-grabbing annual percentage rate (APR) of 9.5, charges a much higher annual interest of 12.3 per cent to customers who do not wish to buy the insurance. First Direct and Marks & Spencer also hike their rates unless you opt in. Even Alliance & Leicester has a similar dual-interest on its top tier for loans of more than pounds 10,000.

This practice has been criticised as "fundamentally wrong" by the chief consumer watchdog, the Office of Fair Trading, which believes that the cost of compulsory insurance should be included in the APR calculation, so that borrowers can easily compare the true price of a loan. An OFT spokesman said: "If an interest policy is mandatory, then we believe it is an essential part of the agreement, and the cost should be reflected in the headline APR rate. Not to do so, in our view, is fundamentally wrong. Where the insurance is not mandatory, then that is a different situation."

This view coincides with that of the European Parliament, whose consumer credit directive is likely to force insurance costs to be included in APRs, when it comes into force later this year. But the regulations as they exist at present are not clear, and the Department of Trade and Industry is consulting over how best to implement the EU directive.

To be fair, some of the lenders themselves are unhappy with the current confusion. A spokesman for First Direct, which slices 2 per cent off its APRs for customers who take out the insurance, said: "We would welcome some clarification. The convention among lenders has been not to include insurance in the APRs, even when they are obligatory, but this can be confusing for customers."

Until then customers should treat APRs with caution. Although Northern Rock's 9.5 APR looks like the cheapest around for a pounds 5,000 loan over three years it actually costs more than Clydesdale Bank's loan which has a headline APR of 12.8, because Northern Rock's insurance is more expensive. A customer would pay pounds 181.88 monthly with Clydesdale, compared with pounds 182.37 at Northern Rock, which makes the former nearly pounds 18 cheaper, despite a higher APR.

Lombard Direct is another lender causing eyebrows to raise. It advertises a league-table-topping headline rate of 11.9 APR, but this is only available to customers with gold-star credit ratings. Customers are assessed individually and given their own APR, depending on their previous debt-repayment record and where they live.

But the really bad boys of the personal-loan field are the main High Street banks. Lloyds, Barclays, and NatWest are all still charging an APR of around 20 per cent on some of their unsecured loans, even though base lending rates have spiralled downwards to 5.5 per cent, giving them a profit margin of 15 percentage points.

Andy Thompson, unsecured lending manager at Egg, denies there is a "fire sale" taking place. "It's not that we new lenders are not making healthy profits. We lend at a good margin. But the traditional lenders, like the High Street banks, are making super-profits. Interest rates have been falling for some time, but there has been very little movement in some lending rates. I believe even the keenly priced loans still have further to fall."

Egg this week trimmed its loan rates further on the upper tiers. Borrowers can now fix their repayments at 13.4 APR on loans between pounds 2,500 and pounds 4,999, 11.9 APR on sums between pounds 5,000 and pounds 9,999 and 10.2 APR on amounts above pounds 10,000.

He argues that banks are now able to offer personal loans more cheaply because of the improvement in credit-rating information. This has made the business so attractive that lenders have been busy designing loans to capture the public's imagination. Unlike traditional packages, Egg allows the debt to be repaid early without penalties, and customers can take repayment holidays as well.

Northern Rock's new Together loan allows customers to borrow up to 95 per cent of the value of their home at a 6.7 APR (the debt is secured). Customers can then borrow an additional 30 per cent of their home's worth. And the Woolwich will allow you to extend your flexible mortgage to raise funds at a two-year fix of 5.75 per cent.