When applying for personal loans, do you think that the amount you borrow makes any significant difference to how much interest you pay back? Take a look at this example…

Question: If you borrow £4,500 from a loans company, how much interest would you expect to pay back?

a) Less than if you borrowed £5,000

b) The same as if you borrowed £5,000

c) More than if you borrowed £5,000

Answer: You might be surprised to hear it’s option c.

So why doesn’t borrowing larger amounts necessarily mean that you pay back more in interest? The reason is that a lot of loan suppliers will often change the APRs (annual percentage rates) they apply to their loans based on the amount of money their customers want to borrow.

For example, if you want to borrow £4,500, the best APR you can currently get is 12.9%, leaving you to pay back £1,533 in interest over a 5 year term.  However, if you borrow £5,000, the best APR you can get is 8.8%, leaving you to pay back £1,150 in interest over the same term. Surprisingly – you end up paying £383 more in interest for borrowing £500 less.

So why is this case? It’s not always clear why companies apply different APRs in this way, but generally, APRs tend to signal how risky the loan supplier feels a customer is. And by ‘risky’ I mean; how likely a customer is to pay back their loan. So the fact that loan suppliers apply a higher APR to small loan amounts could be indicative that they believe these borrowers are riskier customers.

And if you think about it, it makes sense. For example, if a borrower needs to take out a loan for a small amount of say, £500 or £1,000, it may indicate that they don’t have any personal savings to fall back on. The bank may consider this behaviour less financially responsible and as a result, charge a higher APR to counteract the higher risk of default.

When searching for a loan, it is always worth checking what APRs are available for a range of different loan amounts. You may find that by taking out a bigger loan, you can reduce the amount you pay back in interest. If you’re worried about taking out more money, you could put the excess amount into savings or if there’s no penalty, pay the excess back straight away.

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