Personal loans: the pick of 'financial fast foods

The cost of personal loans is only going in one direction, and that's upwards, lenders are warning. Fierce competition between lenders has seen interest rates being pushed lower - so much so that the cheapest unsecured personal loans are undercutting the rates offered by some mortgage lenders.

But there are forecasts that this price-cutting for personal loans is about to come to an end and the next phase will see interest rates nudging higher.

"We're reaching a turning point," says Tesco's head of lending, Allan Burns. "It could take a little time, but the pressure is there for an increase."

This pressure is coming from the increasing cost to lenders from the money markets where they buy the funds for personal loans, he says. It isn't directly linked to the base rate - but the underlying trends are upwards, putting pressure on lenders and reducing their room for manoeuvre. This view is shared by internet bank, Cahoot, which has been at the sharp end of the rate-reducers, with a current lowest of 5.9% APR. "Our view is that unsecured lending is only heading in one direction - up," says a Cahoot spokesperson, who warns of "increases filtering down from the money markets to customers".

The bank's head, Tim Sawyer, says that would-be borrowers "should lock into a cheaper rate now because they won't be around for long". But it might not be all gloom for borrowers, because the intense competition is still likely to apply a brake on any increase.

Anyone with a letterbox and a television can't have missed the tidal wave of ad vertising for personal loans. High street banks, supermarkets, building societies, retail chains, direct lenders and online banks are scrapping as never before to sell us loans, promoting them as a kind of financial fast food, where we can get hold of money quickly and without fuss.

And personal loans have been competing with other types of cheap and cheerful credit, such as 0% credit cards and remortgage offers. This has pushed loan rates down and stimulated more borrowing.

However, Tesco's Allan Burns says that lenders, who have grown dependent on these ever-increasing volumes of sales, are now facing up to the process reversing. They will be looking hard for ways to avoid pushing up the low rates that have been pulling in the borrowers.

In Tesco's case, he says it might mean pulling back on marketing costs, and relying more on selling loans through the supermarkets. Mr Burns says that there will be an element of lenders holding out to see who will blink first. But the rising cost pressures will give lenders less and less scope for keeping rates down.

There are concerned rumblings that lenders will adopt dubious tactics to keep headline interest rates artificially low, such as aggressively selling loan protection insurance. This could see consumers thinking they were getting a bargain from a cheap loan, while the real money for the lender is in over-priced insurance.

Egg has argued against the practice of charging redemption penalties on loans, which it says is used by lenders as a cross-subsidy to keep down APRs. As 70% of borrowers pay off their loans early and more than three quarters of loans have redemption penalties, these extra charges are used to mask the full cost of borrowing.

Nationwide has also campaigned against deceptive headline rates, attacking the practice of advertising "typical" rates, which might be much lower than the actual rate that a borrower might be asked to pay. It says that a single flat rate is much more honest than the different tiers of lending rates, which can often make small borrowing very expensive.

Such concerns show how multi-layered and market-driven the pricing of personal loans has become. This week, for anyone borrowing £2,500 from Marks and Spencer, the rate has risen by almost 5%.

This huge leap isn't because of some earthquake in the money markets but because it was the end of the "winter loan sale". This is about retailing tactics, and as banks become more like shops, marketing rather than money markets can be the biggest factor on rates.

Co-operative Bank spokesman Dave Smith says that the influences of marketing and competition are so great that it's not at all clear cut which way loan rates will go in the future - and he's a dissenter from those saying that it's in evitable that personal loans will become more expensive.

He points to the 0% introductory offers on credit cards and says if it's viable for lenders to provide such deals, it isn't possible to make assumptions that personal loan rates will have to rise. Mr Smith says lenders are sharply aware of how quickly borrowings can be switched from loans to credit cards or mortgages.

It's also the case that the boundaries between different types of lending are blurring. First Direct now offers an "offset loan" as part of its offset mortgage, which allows people to add a loan to their existing mortgage.

This is secured lending and so not like a conventional personal loan. But when it's packaged as a loan, but with a lower mortgage rate, it shows the bidding war can be driven lower.

With rises in base rates setting the mood music for higher borrowing costs, it will be a struggle between the lenders' accountants and the advertising departments to see whether the national loan sale comes to a close.