Car finance and personal loan interest charges to jump £900 a year
Analysis from specialist mortgage lender Pepper Money found that 7.7 million homeowners currently have at least one unsecured loan, with a large number of those being car finance.
Of these, 15% have already seen the interest rate charged on loans increase in the past six months, with the average extra interest costing more than £900 a year. Over the next 12 months, it means British homeowners could be spending an extra £1.6bn in interest payments on unsecured loans.
Why are interest rates rising?
The Bank of England has been steadily hiking the base rate in a desperate attempt to bring inflation, already over 10% and expected to hit at least 13%, under control.
In the first week of August, the monetary policy committee at the Bank of England confirmed base rate would rise to 1.75%, the fifth hike so far this year and the sixth in the past 12 months.
Bank of England governor Andrew Bailey has indicated there will be a further two hikes later this year with markets now pricing in a base rate of 3% by early next year.
Lenders have been quick to pass on higher rates to customers. Moneyfacts data showed that between the start of March and the start of June, the average rate on a £7,500 loan stood at 5.2%, the highest it has been in six years.
Average unsecured personal loan rates for £5,000 over three years, £7,500 over five years and £10,000 over five years were all up compared to the beginning of March 2022.
The cost of higher loan rates
Anyone paying down car finance or personal loans will be hit by higher costs, not just those who own their home.
According to The Money Charity, the average adult in the UK currently has £3,823 outstanding in unsecured debt. Based on a loan rate of 5.2%, annual interest charges currently total £199.
Paula John, an independent mortgage specialist, said: “The spiralling cost of living is putting the squeeze on everyone’s finances as the price of essentials like food and fuel continues to rise.
“The situation is exacerbated as interest rate rises mean that the cost of borrowing has also increased. Customers with outstanding credit including unsecured loans could also see their payments increase.”
While some personal loans and car finance is agreed on a fixed rate of interest for the duration, many have a variable rate that can rise in line with interest rate increases.
John said: “This means that the cost of paying the interest also rises, putting further pressure on finances.”
Should you consolidate expensive debt?
Laurence Morey, Pepper’s chief executive, said: “We know that the monthly commitment of servicing short-term debts such as personal loans can put extra pressure on family finances if the cost of servicing those loans is increasing.
“In these circumstances, consolidating those debts by refinancing onto a homeowner loan at a lower rate could potentially put families in greater control of their finances, enabling them pay down that credit over the longer term.”
Debt consolidation may not be the right avenue for everyone, but Morey said in the “right circumstances” consolidating expensive short-term credit onto a longer-term loan at a lower rate can help to put families in greater control of their cash flows. Homeowners are particularly well placed to pay off debts by taking a larger mortgage when they refinance, he added.
Mortgage rates tend to be lower than the cost of servicing personal loans and car finance meaning that although the debt is still there, you’re paying your lender much less interest than you were being charged by your bank or credit card provider.
For example, NatWest currently has a two-year fixed rate mortgage charging 3.19%. Although you’d have to pay a fee to remortgage onto this particular deal, the interest charged on that £3,823 average outstanding loan, if you added it to your mortgage would be just £122 over the year – enabling you to pay more than the interest each month and reduce the debt over time.
Moneyfacts finance expert Rachel Springall cautioned: “Anyone comparing deals, whether that be to consolidate debts with a loan or move their credit card balance to an interest-free deal, would be wise to check their credit score with Experian, Equifax or Totally Money before they apply.
“The months ahead are uncertain amid the rise in the cost of living but seeking advice from a debt advice charity is also wise should borrowers be struggling or fear they will be unable to keep up with their repayments.”
Before you make any decisions to take on a larger mortgage, it’s a good idea to speak to an independent financial adviser or mortgage broker who will able to help you understand the financial implications of consolidating debt this way.