Large Loans Cost Less

The more you borrow, the lower the average interest rate you'll pay...

This article was first sent to Fools in an email as part of our Summer Lolly campaign.

"Summertime, And the livin' is easy

Fish are jumpin', And the cotton is high

Your daddy's rich, And your mamma's good lookin'

So hush little baby, Don't you cry"

(Summertime by George Gershwin; lyrics by Ira Gershwin and DuBose Heyward)

So, summer's great when your daddy's rich, but one about if -- like many of us -- you're short of a few bob? For example, what if you need to make a major purchase (such as home improvements, a car, holiday or wedding), but don't have the savings set aside to pay for it?

One answer is to bide your time and save up in a high-interest savings account. The alternative is to borrow the money as cheaply as possible. For example, you could do this is via a low-cost personal loan. I explain how to do this in How To Find A Cheap Personal Loan.

As a committed anti-debt campaigner, I do my level best to convince people not to get into too much debt. However, it is a fact that personal loans become much cheaper the more you borrow. It works like this: the larger the loan, the lower your interest rate.

According to Fool partner Moneyfacts, you have a choice of 72 different lenders when it comes to picking a personal loan. The majority of these lenders charge lower APRs (Annual Percentage Rates) as loans get larger. However, some lenders don't charge these `tiered' interest rates, making them better bets for smaller loans.

Let me show you what I mean, using three different loan amounts, all borrowed over three years:

Best Buy personal loans of £5,000 over three years (excluding rip-off payment protection insurance)

As you can see, the interest charged per £1,000 borrowed varies from £106.50 at YourPersonalLoan to £120.39 at Moneyback Bank. Now let's look at a loan that's twice as large:

Best Buy personal loans of £10,000 over three years (without PPI)

As you can see, the average interest bill has come down by £2.56 per £1,000 borrowed. Now let's add another £5,000 to our loan:

Best Buy personal loans of £15,000 over three years (without PPI)

So, as you can see, borrowing even more lowers our average interest charge to just £108.56 per £1,000 borrowed.

In summary, it's true to say that the more you borrow, the lower the average interest rate you'll pay. Then again, it makes no sense to borrow a lot more money just so as to bring down your interest rate. During so would simply increase your overall interest bill and leave you worse off!

Nevertheless, it may make sense to borrow, say, £5,000 instead of £4,990, in order to benefit from a lower rate. So, before borrowing, do check to see if you can save money by stepping up to the next interest-rate tier.