Although 2011 has seen a price war break out between loan providers desperate to secure business, low-level borrowers aren't benefitting - far from it.
Loan rates tend to be higher the less you want to borrow, so if you only need a small sum, you won’t get some of the headline-grabbing rates currently advertised. These rates, which are as low as 7.2%, usually apply to loans of at least £7,500.
But, if you want to borrow just £3,000 over two years, then the best rate you can get is 12.6%, making a credit card a much better bet.
The best credit cards for purchases
Several credit card companies offer 0% introductory interest-free periods on purchases for new customers.
The market-leading purchase credit card is the Tesco Clubcard Credit Card, offering 13 months at 0% on new purchases.
That means that if you can clear your debt within the introductory period, you wouldn't have to pay pay a penny in interest on your borrowing. This represents a saving of £387, compared to if you went for the best loan over two years.
However, you must be certain you can repay your debt during the interest-free period, as after these offers end, rates on credit cards tend to be higher than on loans.
It can be easy to get trapped in a cycle of paying off just the minimum amount each month, prolonging the length of time it takes you to clear your debt. Over time, that's going to cost you far more in interest than the best-priced loan, so think carefully about how quickly you will be able to pay off what you owe.
If you are sure you can pay down your debts within a year, then the next best credit card deal is from Sainsbury's, which offers 12 months at 0% on purchases and balance transfers, although you pay a fee of 3.00% for moving a balance across.
That means that you can use it to make interest-free purchases for the first 12 months, but also to cut the cost of any existing credit card debt. This card has a representative annual percentage rate (APR) of 15.9% variable and you need a Nectar card to qualify. These can be collected inside a Sainsbury's store, just add the loyalty points from at least one purchase in the shop and you're ready to go.
Another option is the Barclaycard Platinum with Purchase card, which also offers a full year at 0% on purchases and balance transfers, with a 2.9% fee for transfers.
Its representative APR is 18.9% variable, meaning you definitely want to clear the balance before the interest-free period ends.
Pros and cons of loans and cards
When weighing up the benefits of credit cards and loans, it is worth remembering that a credit card offers you extra protection under the Consumer Credit Directive, giving you another avenue for a refund if something goes wrong with your purchase. You do not have this extra protection with a loan.
However, the main benefit of a loan is that managing your debt is pretty straightforward; a fixed amount leaves your account each month until the sum is paid back. You can usually clear the debt early if you're able, although that will normally mean you pay an early redemption penalty.
But with a credit card you can pay as much as you like each month, as long as the minimum payment is met. That flexibility can cause problems if you aren't very self-disciplined about clearing the debt.
Another difficulty with a credit card is that, until you make your application, you don't know what credit limit you'll be offered. Unlike a loan, you cannot ask for a specific amount.
So, if you needed £3,000, say for a new car, there is a risk that a credit card company could offer you less, depending on your credit score, history and income.
Unfortunately, every time you make an application, it's logged on your credit file and can put off other lenders. That means that you may then struggle to be accepted elsewhere, if you decided to look for a different card or loan because you haven’t been offered a high enough limit.
The best loans for small borrowing
If you decide that a credit card is not for you, then where can you find the best loan rates if you only want to borrow a small amount?
To borrow £3,000 over two years, the cheapest rate you’d get is 12.6% variable representative APR from Sainsbury's Finance, meaning you'd pay £141.12 a month. The total interest over the term would be £387.
If you have any other outstanding debt then it might be worth considering consolidating that and your new borrowing into one large loan, to take advantage of the lower rates.
For example, if you wanted to borrow £7,500 over five years, then the best rate going is from Alliance & Leicester or Sainsbury's, which both offer a representative APR of 7.2% variable. That would cost you £1,405 in interest over the full term, with monthly repayments costing £148.41.
The next best deals are from Santander and Nationwide, through a moneysupermarket.com exclusive, at a representative APR of 7.3% variable. At that rate, you'd pay total interest of £1,424 over the term and your monthly repayments would be £148.74.
Check your credit file
There’s never a guarantee that you'll be accepted for a loan or credit card, but you can help your chances by making realistic applications.
For example, someone with a poor credit score is never going to be offered the best rate on a loan, or a market-leading credit card, and rejected applications can harm their score.
Check your credit file before applying for any borrowing, so you can see how likely you are to be accepted.