How credit cards can be cheaper than loans

	Typical APR Variable	Max Int Free
	14.9%	56 days
	14.9%	56 days
	14.9%	56 days
	14.9%	56 days
	15.9%	56 days
* Based on Lowest Standard Rates and is not a full search of the whole market

Look at the wonderful array of cheap unsecured loans on the market at around 5.5%! You might be fooled into thinking that these are much cheaper than borrowing on a credit card which can cost you between 13.9% and 16.9%. But you may be surprised to know that credit card borrowing can be the best option.

When you consider that a personal loan can be over a year or up to 15 years, sometimes taking out a short-term debt with a credit card over a few months can be cheaper than paying a lower interest rate loan over 15 years. By taking out a personal loan you are turning what might be short-term debt into medium- or even long-term debt.

Recently there has been a spate of cut price loan deals on the market as competition has increased. You can get loans as low as 5.5% from Moneyback Bank, 5.6% from Cahoot and 5.8% from Northern Rock. However, you also have to realise that you might not get the typical interest rate advertised. Around 66% of us should get the typical rate but you may get offered a higher rate depending on your credit rating.

On top of this, lenders will often try to sell you payment protection insurance which they add in as a lump sum at the beginning of the loan. This means you are paying interest on this as well - meaning you are borrowing more than you think. At the beginning of the loan you are mainly paying interest. But if towards end of the term your loan starts to get small enough to pay it off entirely you might find there's a redemption fee for repaying the loan early.

Cahoot is one of the few institutions to offer a flexible loan at 6.9% - you borrow when you need to and only pay interest on what you borrow. At any time, you can repay the full amount without paying a fee. If you know you are getting a bonus, a windfall or another type of payout at a certain time to pay off the credit card debit, even though you might be paying a higher rate of interest, its going to be cheaper than a loan.

Using a credit card is especially good when it's free or almost free. With overdraft interest rates between 7.7% and 8.5% on best buy current accounts and between 5.5% to 6.7% on personal loans, the 0% credit card sounds rather heavenly. It is, well almost - that is until you realise that many credit card providers now charge a 2% fee on balance transfers to open an account and that the 0% normally applies to balance transfers only. Some lenders cap the 2% fee at £50 but beware! Others don't - you need to read the small print. Even so, it is considerably cheaper than the alternatives.

The main problem is that there are fewer and fewer zero rates deals around. The Halifax One is one of the few left that stretches the 0% deal to 12 months while a number such as Abbey and Alliance & Leicester Online offer a zero-rated credit card for nine months. HSBC offers 0% on transfers and purchases but only for six months.

If you are thinking of borrowing short-term on a credit card it isn't just the interest rate you need to consider. The 0% deals are said to have cost the credit card industry around £600 million a year and now they are faced with having to claw back their losses. That's why they introduced the 2% transfer fee and have cut back on incentives such as cashbacks and interest free days. Egg now offers 45 interest free days, Cahoot 46 while others such as American Express, Marbles and Virgin Money still offer 56 days.

Always make sure you pay on time as late payment fees can be up to £35. As so many of us have enjoyed the 0% bonanza, credit card issuers have seen huge numbers of us switch our cards. To help it hang on to customers Egg has just introduced a deal where you get a balance transfer rate of 0% for nine months and 0% on purchases for six months. To stop customers switching after this, it offers a five month 0% deal on balance transfers in 2007 and again in 2008.

15 July 2008 © Moneyextra.com

back

Moneyextra.com recommends you should consider taking independent financial advice before acting on any article. Please contact us for help with your individual circumstances if any assistance is required.