Wealth Check: Beware the cost of loan insurance

Chris Nowell, a warehouse supervisor from Atherton in Lancashire, is 38 years old. He lives with his partner Nichola and his two youngest daughters.

Chris recently switched two loans and a credit-card account to Royal Bank of Scotland: he took out one unsecured loan of £10,500 to consolidate all three debts, and is now paying an interest rate of 12.6 per cent. The debt must be paid back over five years, and Chris borrowed a little bit extra in order to leave some funds for home improvements.

Chris is concerned that he's not getting the best possible deal from RBS, and is also debating whether to take out the payment protection insurance (PPI) the bank has offered. The price of the insurance is a quarter of the loan itself.

Chris doesn't have a pension, but his partner pays £10 a month into her employer's occupational pension scheme. Chris would like the family to receive a similar level of income to what he earns now when he retires.

We asked Shane Craig of Paymentcare, Anna Bowes of Chase de Vere and Andrew Merricks of Skerrit Consultants for their advice.

Loan

If Chris has a decent credit rating he can certainly reduce the interest rate he's being charged on the loan, says Anna Bowes. The internet bank Cahoot, for example, is offering a five-year loan with an interest rate of 5.8 per cent a year - the monthly repayments on this would be about £200 for a loan of £10,500.

If this loan were extended for an additional two years, the repayment amount would fall by £50 a month, which could then be redirected to savings - either for a property or a pension. However, extending the loan will mean that Chris ends up paying back more in total.

Another option, Bowes suggests, would be to transfer at least some of the debt to credit cards offering interest-free introductory periods, reducing the interest payable on this part of the borrowing to 0 per cent. Egg, for example, offers such a deal.

If he takes this option, Chris must be very careful to make sure he switches to a new deal before higher interest rates kick in at the end of the offer period. But in the meantime, he will be paying off capital rather than interest charges.

Andrew Merricks warns that because Chris is living in rented accommodation, the best interest rates advertised on TV and in the newspapers may not be available. The best deals on loans - rightly or wrongly - are generally reserved for homeowners.

In which case, Royal Bank of Scotland's rate may be less expensive than it first appears, and the bank doesn't charge early redemption penalties, unlike many other lenders. Even so, it's worth getting quotes from rival loan providers.

Loan Insurance

Shane Craig says Chris should look elsewhere to track down the cheapest PPI policy. Banks and building societies rarely offer good value on this cover. On Tuesday, a report from Citizens Advice warned borrowers that PPI is generally overpriced and often riddled with small print.

However, many borrowers want the security blanket of loan protection. The insurance pays out if borrowers are unable to keep up with loan repayments because they lose their jobs or can't work due to ill-health or an accident.

Chris needs to compare quotes from stand-alone, independent providers who can slash the cost of cover by up to 50 per cent, says Craig. He suggests Chris opts for short-term income protection covering all his outstanding debts.

Merricks agrees that Chris is right to be wary about RBS's PPI insurance - it will significantly increase the cost of repayments. Very often, the benefit received under the sickness or disability part of the contract is worse than what permanent health insurance (PHI) would pay, he says. A typical PPI contract will only pay out for 12 months, while PHI will pay out for as long as is needed, even though premiums are similar.

Unemployment cover is also an easy sell for lenders, warns Merricks, as losing your job is a common fear. However, Chris needs to check the terms under which the policy will pay out. Will it cover him if he is sacked, for example? Most likely not, so how likely is it that he is going to be made redundant?

If the answer is "not very", it may make more sense to set aside what he would have paid in premiums into a savings account for the future.

Pension

Chris needs to be realistic about his expected income in retirement, stresses Bowes. It's good his partner saves something, but £10 a month will yield a very small pension income - probably less than £500 a year, in today's money.

As a starting point to planning for old age, Chris should ask for forecasts of his state pension, available from the Retirement Pension Forecasting team on 0845 300 016.

Property

Bowes says Chris should remember that if he continues to rent for the rest of his life, his rent will rise over the years. If he and his partner are able to get themselves on the property ladder, they may be better off over the longer term.

Depending on the type of property they rent, the couple may be entitled to participate in the "right to buy" scheme. If they can't afford to buy a whole property straight off, they could find out about shared ownership - through a housing association, for example. They can buy further shares later in life when they have the money.

Case notes

Chris Nowell, 38, supervisor, Lancashire

Personal: Chris, a warehouse supervisor, needs to find the most competitive way of paying back a large personal loan. He also needs some advice on pension planning so that he and his partner Nichola (also pictured) can look forward to a better standard of living later in life.

Income: Family income of £20,000 a year. Both Chris and Nichola work.

Debts: £10,500 unsecured loan - Chris recently consolidated a range of debts into one loan from Royal Bank of Scotland and added to his borrowings in order to pay for home improvements.

Savings and pension: Chris has no private pension savings of his own but Nichola makes contributions of £10 a month to private pension. The couple are not sure what to expect from their State pensions.

Property: The couple rent their home in Atherton, Lancashire.

Protection: Chris is not sure whether to take up Royal Bank of Scotland's offer of payment protection insurance, which would cover him if he can't make loan repayments due to ill-health or unemployment.

Monthly outgoings: The couple pay rent of £220 a month, plus they have other living expenses that together total £800.