Two ways to get wise about taking a personal loan

Planning on buying a car, or booking that long awaited holiday, and not enough money in the bank? You are not alone – but being wise about it can save you thousands of dollars.

An obvious solution would be to take out a personal loan. Personal loans are short to medium term loans extended to you by the banks and other non-bank lending companies. The mechanics are pretty simple.

The lender provides you the money to spend now, on the basis that you repay them not only the entire amount borrowed but also an additional amount (called the ‘interest’ payment) over the following months or years. That additional amount you pay is the cost of borrowing that amount.

That cost of borrowing will depend on whether you have something to put as a security for the benefit of the lender. For example, say you take out a loan for buying a car. If you agree with the lender that they could take possession of the car if you missed any of your repayments then that car is the security. Alternatively, you could take the loan amount and not provide anything back as security. The former is an example of a secured loan and the latter an unsecured loan.

Clearly, the latter case is more risky for the lender. The risk being that you don’t repay the borrowed amount and/or the interest and they are left with no recourse. In the former case, they can take possession of the car and sell it to recoup the borrowed amount.

For that reason, you will find that the cost of a secured loan today will range between 8.95% and 13.95%. On the other hand, the cost of an unsecured loan can vary between 6.99% (with Harmoney) and 17.95%.

To make this more explicit, if you were to take a $15,000 personal loan for 3 years, you could pay anywhere between $477 and $513 a month for a secured loan, or between $464 and $542 a month for an unsecured loan. As obvious as it is, this means that if you shop around, you could save about $1,300 on a secured loan and about $3,000 on an unsecured loan. Not bad for starters!

Be wise, shop around before you commit to borrowing.

Nonetheless, you could get even wiser about your borrowing decision.

Say you have a home loan (with a mortgage on your house) already. If you have paid down enough of your loan it may very well be possible that the lender may consider topping your loan up with the additional dollars that you are looking to put to immediate use on a car or a holiday.

Why would this option be much wiser?

That’s simple! The cost of borrowing on your home loan is lesser than the cost of taking a personal loan. To put that into context, home loan rates today range from 4.39% for a three-year term at ASB, to 4.85% at other banks such as Westpac, Kiwibank, Co-operative Bank etc.

Clearly, at these rates, it is far cheaper to borrow the additional amount you want using a home loan top up rather than via a personal loan. Given that your home loan has your house as security, it is reasonable to compare the difference in costs with equivalent ‘secured’ loans. Under the home loan top up option your monthly repayments will be anywhere between $445 and $450. Over three years that is a saving of $2,300!

You can compare all your borrowing options right now, right here on PocketWise.