TSB to offer small short-term loans as an alternative to overdrafts

TSB says it plans to unveil a new range of short-term loans to help overdraft borrowers avoid turning to payday loans. Will other lenders follow suit?

From April banks will have to change how they charge for arranged overdrafts which will see borrowers facing interest as high as 49.9% EAR.

While the majority will pay less or the same amount it's estimated three in 10 could pay more and the regulator has suggested those struggling should look to 'other methods of credit'.

More borrowers are expected to turn to personal loans as a safe option. But right now, these products aren't a great fit for short-term borrowing.

Here, Which? explains what TSB has planned, why the personal loan market needs to improve and the cheapest small personal loans to go for if you want to clear your overdraft.

What has TSB got planned for loans?

TSB is considering offering smaller loans for up to one year as an alternative to overdrafts.

We asked the bank to elaborate, but it didn't have any details of the products it might offer that could help overdraft borrowers steer clear of payday loans or other high-cost credit.

A TSB spokesperson said:'Customers have told us they want more help managing short-term cash flow problems, and they want a bank that provides better options when borrowing for shorter periods.

'We're currently in the process of developing short term lending products to better serve our customer's needs.'

TSB as part of an industry-wide shift will raise its overdraft rate to 39.9% EAR from April. Currently, the smallest loan TSB offers is £1,000 which you can take out over two years at 27.9% APR.

The bank could make the rate more competitive on small loans and offer shorter terms under two years - and other banks may follow suit.

This could kick start some competition between lenders in small short-term loans that typically mirror overdraft borrowing levels.

However, when we asked the major providers about upcoming changes to their loans, none had any similar plans to share.

Why do banks need to innovate on small loans?

Personal loans are a good way to borrow if you need a large sum of money and typically they get cheaper the more you borrow.

The sweet spot tends to be in the £7,500 to £15,000 range where rates are as low as 2.8% APR.

However, those looking to borrow small amounts which mirror typical overdraft limits of £1,000, pay much more.

Our analysis has found a small personal loan for £1,000 can be as much as 28.9% APR, and it could be higher if you haven't got a perfect credit history.

Furthermore, if you want to pay more off your loan each month than is required, or want to pay it off entirely with a lump sum before the end of the term, some lenders might charge you a penalty for the privilege.

Which? analysis last year found 59% of lenders in the market charged an early repayment charge on their person loans.

• Find out more:personal loans explained

How much can you borrow with a small loan now?

You won't be able to borrow less than £1,000 using a personal loan with a major high street bank according to our research.

The smallest amount you could borrow starts at £1,000 and the shortest time period you could spread repayments is one year.

Which? analysis of Moneyfacts data found 32 unsecured loans on offer from 21 banks willing to lend £1,000 over one year.

Of these, 18 deals were available to new and existing customers and 14 were only open to existing customers.

Which providers offer small personal loans?

You won't be able to borrow less than £1,000 with a major high street bank according to our research.

The smallest amount you could borrow starts at £1,000 and the shortest time period you could spread repayments is one year.

Which? analysis of Moneyfacts data found 32 unsecured loans on offer from 21 banks willing to lend £1,000 over one year.

Of these, 18 deals were available to new and existing customers and 14 were only open to existing customers.

The cheapest short-term loans

You can check out the rates on small personal loans for borrowing £1,000 over a year in the table below ordered from cheapest to most expensive.

The cheapest small personal loan is offered by Allied Irish Bank (AIB) for 12.6% APR and is available to new and existing customers.

If you took out the AIB loan and if you paid it off on time, your total repayment would be £1,065.72. So the cost of borrowing £1,000 for a year at 12.6% APR would be £65.72.

The most expensive in this niche comes from Halifax, which offers an APR of 28.9%.

If you took out the Halifax loan your total repayment would be £1,144.32, so the cost of borrowing would be £144.32 - £78.60 more than the cheapest deal on offer.

That said from April, Halifax's small personal loan will be cheaper than its overdraft which will shift to 39.9% EAR or 49.9% EAR depending on your account and credit profile.

• Find out more:the best rates for loans of £,5000, £10,000 and £15,000

Should you get a personal loan?

To get the best rates on a personal loan you will need to have a good credit history.

Lenders only have to offer their top rate to 51% of those that apply, so are able to offer 49% a worse deal if they choose to.

If you get a personal loan you also have to make set repayments, and missing one could get recorded on your credit report and harm your chances of getting future credit.

Personal loans also don't offer 'revolving credit'.

This means when you make repayments your balance isn't refreshed and you won't be able to spend that money again like you would with an overdraft or credit card.

What to do if you're struggling with overdraft debt

If you have a large overdraft and are worried about what to do once the new rates kick-in take a look at our story on how to clear your overdraft.

It might make sense to use your savings or to consider a 0% money transfer credit card.

• Find out more:how to get out of you overdraft before rates go up