This piece first appeared in Reader's Digest in August 2000
 The text here may not be identical to the published text

Neither a borrower nor a lender be, that was the advice of Shakespeare in Hamlet. Nowadays, of course, most of us are both – squirreling away our money in bank accounts that pay low rates of interest or none at all, while we borrow to buy a house, a hi-fi, even a holiday and pay through the nose.

The cheapest loan you can ever get is from yourself. If you need money to buy something, think about borrowing from your savings. Of course, you have to be very disciplined. Treat it like a real loan. Set yourself a repayment schedule, make out a direct debit transferring money from your current account back into your savings, and forget about it until the money is re-paid. Then all you have lost is the interest your money would have earned. The savings over a bank loan can be significant. Suppose you want a new wide-screen television. It is £1000. But you have £2000 in a building society account earning 4% a year. You take the money out of the building society make out a standing order to your building society account for £83.34 a month. And in a year it is paid for. That has cost you just £20 in lost interest – remember that the money you pay in each month starts earning interest again. If you borrowed the money from Abbey National it would cost you £87 in interest over a year. So you save £67 by doing it yourself.

Okay, you say but my savings are for emergencies. Fine. If an emergency strikes and that £1000 is crucial, borrow it from the bank then. Emergencies by their nature are rare events. So chances are you will end up better off and you will not end up worse off even if disaster strikes.

But, you say, you like having savings, it gives you a sense of security. You would rather have a loan of £1000 and savings of £1000 then one bank account with a balance of zero. You somehow feel richer, or safer anyway. Fine. I know that feeling. For many years I operated a savings account to pay my taxes and a big (agreed) overdraft. Even though that cost me money, I preferred to have the money in the bank to pay my tax when the bills arrived and treat the overdraft as a separate cost of, well, living. The interest on the overdraft was around £150 a year more than the interest on the savings. As I said to my bank manager - that’s the price I pay to sleep at night. So whether you have some savings but, like me, you want to keep them, or they are not enough, or you do not have any savings at all – and you need some money now, then you have to borrow.

Rule number one. Do not borrow it from the person who sells you the goods. We spend hours looking for the dishwasher, or sofa, or car, or computer we want. Then we spend ages finding the best price. But when we are offered a finance package we say ‘OK’ without even finding out if there are better deals around – and there nearly always are.

Let’s pick a more sensible amount to borrow. You need £5000 – for a new kitchen, a cruise, or maybe a wedding – and you want to pay it back over three years. At the moment the very cheapest loan is from Northern Rock at an interest rate of 8.8% APR. (Annual Percentage Rate is a way of calculating interest to that you can compare one interest rate with another fairly, taking into account any fees, the repayment period, and the loan.) At that rate you will pay £157.75 each month for 36 months. At the end you will have paid back £5769 – so the credit will have cost you £769. That is very cheap. A more typical rate is the 12.9% charged by the Co-operative Bank. That will cost you £166.62 a month – which means you will pay £998.28 to borrow £5000 over three years. And if you want to pay more, no problem. West Bromwich Building Society will charge non-customers £184.60 a month. Over three years you will pay £1645 on top of your £5000 for the privilege of borrowing at 18.9% - one of the highest rates around. Of course, some of the cheaper deals come with strings. You will have to pay by direct debit and have a good credit rating. But finding the best deal can save you hundreds of pounds over the three years of the loan.

Lenders don’t stop here when it comes to taking your money off you. The cost of credit can easily be doubled by inviting you to take out insurance. For example, Smile will lend you £5000 over three years quoting an APR of 11.9%. But if you add on the cost of insuring your repayments, that APR would be more than 24%. Lenders do not have to include the insurance costs in the APR as long as it is not a condition of the loan.

These insurance policies pay up if you can no longer meet the repayments through illness or unemployment. But be very careful before paying for one. Many people have paid the money only to find that they did not have the protection they thought they were paying for. Illness cover will usually exclude any existing condition that you know about, or should know you have. Unemployment cover will only pay up if you lose your job through no fault of your own – which usually means only involuntary redundancy. And self-employed people and contract workers may not be covered at all. If you do decide insurance is for you – I have never taken it out in a long life of borrowing – then check the terms and the cost carefully. The cheapest adds 62% to the total cost of the loan, the dearest adds 128%. With insurance, a £5000 loan over three years can vary in cost from £179.60 a month from Vivid (funded by Yorkshire Bank) to £220.57 from Cheshire building society. Over three years, the Cheshire deal will cost you nearly £3000, double the cost of the loan from Vivid – and all to borrow £5000. Sadly, if you want insurance you are stuck with the product the lender offers you – no major insurer offers it as a standalone product on personal loans.

Some people borrow money and then find themselves in the happy position of coming into some cash – a bonus, the lottery, a premium bond, an inheritance. But be warned, there may be penalties in paying loans off early – anything up to two months’ interest. And you will also find that your early payments will be used to repay interest before the loan is significantly reduced. So the cost of repaying the loan early can be considerable.

So if you must borrow, check out the interest rate, the total cost, the terms of the insurance, and, if you want to buy it, the cost. And shop around. It could save you thousands.

Rates and repayments provided by MoneyFacts from information supplied by the companies – correct at 11 May 2000. MoneyFacts 01603 476 100

Abbey National 0845 754 5556

Cheshire Building Society 0800 515 904

Co-operative Bank 0800 346 494

Northern Rock 0845 605 0808

Smile www.smile.co.uk [no telephone]

Vivid 0800 028 6898

West Bromwich Building Society 0121 580 6404

Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.

Hamlet Polonius to Laertes, Act I Scene 3

August 2000

e-mail Paul Lewis on paul@paullewis.co.uk