Borrow more to pay less

ROBBING Peter to pay Paul is not normally considered to be good advice but borrowing from Peter at reasonable interest rates over a longer period of time, in order to repay Paul's extortionate short-term rates, makes good sense for most people - provided they do not succumb to the temptation to borrow more and spend it.

Debt consolidation, or taking out one loan to repay a number of existing debts, makes some sense if it simplifies the task of making repayments, especially if the interest is paid just after the monthly pay cheque arrives. But it makes sense only if it reduces interest payments, and preferably reduces the total cost of the credit.

Stuart Davidson, team leader of the Money Advice Support Unit at the National Association of Citizens' Advice Bureaux, says that each case should be considered on its merits. And in no case should borrowers swap unsecured debts for a loan secured on their home because that puts their home at risk.

Sometimes it pays to consolidate debts on to a credit card if you are confident you can pay them off in a few months. At the moment there are a number of special offers around with new card providers, such as Capital One, offering rates of just 6.9 per cent until next year on balances transferred from other cards.

But credit cards and store cards are often part of the problem. Monthly rates of interest charged on some established credit cards frequently work out at 22 per cent a year, because borrowers who fail to repay interest in full are immediately paying interest on unpaid interest. Store cards can be more expensive.

The cheapest source of long-term money is to increase the mortgage, although interest on such loans is not eligible for tax relief even if the total debt is still less than pounds 30,000. But mortgages are secured loans, and the house or flat is at risk if you fail to keep up the payments. Remortgages are in any case of no use to people who are renting.

Bank overdrafts are sometimes a viable alternative, especially for short- term credit that can be paid off within months. Bank of Scotland Direct is charging 11 per cent a year and Alliance & Leicester 12 per cent for authorised overdrafts. But borrowing first and asking afterwards is a recipe for trouble as most banks will charge around 28 per cent a year for overdrafts that have not been authorised.

The next cheapest source of finance will be a personal loan from a bank or building society. Personal loans are available for a wide range of purposes, of which buying a car is the most popular. But Peter Ramsdale, senior manager at Alliance & Leicester, says almost half the recent applications for personal loans have come from customers wanting a loan to settle credit and store card bills.

Unlike mortgages, personal loans are not secured so your home is not at risk, but interest rates average around 12 per cent fixed, usually for between two and five years. Monthly payments are a function of the interest rate being charged, the length of time over which the loan has to be repaid and any extra charges built into the loan, of which arrangement fees, repayment insurance and penalties for paying the loan off early are the most important.

The rate of interest on personal loans is fixed for the lifetime of the loan, and rates have been coming down, so it makes sense to look for the best buys. Last week Yorkshire Bank announced new rates of interest ranging from 12.2 per cent on loans over pounds 10,000 for up to seven years (with no arrangement fees and no penalties for paying off early), rising to 17.7 per cent on loans between pounds 1,500 and pounds 3,000 and 26.6 per cent on amounts under pounds 500.

Barclayloan will now lend up to pounds 15,000 for up to five years. At 13.9 per cent APR for pounds 12,000 to pounds 15,000, rising to 20.9 per cent on pounds 500 to pounds 3,400, it is not necessarily the cheapest but unlike Bank of Scotland, which has an APR of 12.2 per cent and an arrangement fee of 2 per cent, Barclayloan has no arrangement fee. Many other lenders require one or two months' extra interest if customers want to pay loans off early but Barclayloan levies no extra charge. A few lenders, including NatWest Bank and Britannia Building Society, require borrowers to have an account with the lender and Marks & Spencer loans are only available to M&S cardholders.