What’s the best and cheapest way to borrow a small amount?

When needing to borrow a small amount of money, most people will head straight for their bank – but this could be an expensive mistake.

Despite record low interest rates on personal loans, borrowing a smaller sum can be expensive, with much higher rates charged to borrow a few thousand pounds than are offered on larger amounts. 

To help take the mystery out of finding the most affordable method of borrowing for your needs, This is Money has taken a look at the most cost-effective ways to borrow less than £5,000.

Ideally we would all have a savings buffer to pay for unexpected costs and planned purchases. Using your savings comes with no risks or extra costs – no interest applied to your balance or arrangement fees. 

But if you do need to borrow, there are a whole host of options available, some which could save you a bundle and some you should try to sidestep at all costs.

So how much would a personal loan cost?

Thanks to the 0.25 per cent Bank of England Base Rate, the cost of borrowing is at an all-time low.

But while households borrowing between £7,500 and £15,000 can find rates as low as 2.8 per cent, those who need less can end up paying much more.    

The cheapest rate you can get on a £5,000 loan is 3.6 per cent – currently offered by both M&S Bank and TSB.

Rates on this amount however can be much higher, the average borrower paying closer to 7.4 per cent, according to figures from Moneyfacts.co.uk.

Repaying over three years, this would cost you double the amount in interest at £555 compared to the cheapest deals, clocking up £277 in interest. As you borrow less the price shoots up further. 

The cheapest deal on a £1,000 loan is 6 per cent from Lending Works – a whopping 14 per cent lower than the average rate at 20.6 per cent.

Despite the higher rates however, a personal loan does have one major advantage – it won’t let you change your monthly repayments.

This could make it a sensible option, particularly compared to a credit card, if you are concerned you may not be disciplined about paying off your balance if you are given the flexibility.

>Skip to This is Money’s round-up of the cheapest loans 

Buy it with 0 per cent interest on credit to save over £230 

There are several different types of specialist credit card which, providing you are disciplined about paying off the balance, won’t charge you interest.

This 0 per cent promotional period typically stretches for two or three years, but some balance transfer deals offer up to a maximum of 43 months. 

There is however one very important rule with purchase, money transfer and balance transfer cards – you must clear them before the promotional 0 per cent interest deal ends or you’ll be hit with interest of up to 20 per cent.

The best way to do this is to work out how much you will need to pay each month to clear the debt in time, set up a direct debit and don’t touch it.   

Standard rates of 18 or 19 per cent will be applied as soon as the interest-free term ends, which can quickly make it more expensive than a personal loan if you have left a large balance on the card.  

>Skip to This is Money’s round-up of the best and cheapest credit cards  

0 per cent interest: If used sensibly a credit card could cut your borrowing costs

Purchase cards: Cheapest option if you can repay quickly 

If you plan on buying a big-ticket item such as a new sofa, or making a series of expensive purchases you can use a 0 per cent interest purchase card to spread the costs.

If you pay it back in full before the interest-free deal ends, this is usually the cheapest option if you need to borrow as, unlike a money or balance transfer credit card, there are no extra handling fees.

Five years ago the best 0 per cent purchase card you could find lasted just 12 months, according to figures from Moneyfacts. Borrowers can now get a whopping 30 months, from Halifax.

While you will be able to spread repayments over a longer term with a personal loan, you could save as much as £232 in interest compared to a £5,000 loan (charging 3.6 per cent) repaid over 30 months. 

If you need to borrow just £1,000 you would pay a total of £30, compared to interest charges of £463 on a personal loan with a rate of 6 per cent. 

Money transfers: Best option to pay in cash, clear your overdraft or if you want longer to repay

A money-transfer credit card alternatively will allow you to move cash from your credit card to a current account for a small handling fee (usually around 4 per cent).

These can be a particularly useful tool for those looking to clear an expensive overdraft allowing you to pay off the balance gradually without incurring hefty interest overdraft usage fees.

You can also utilise these offers if you are planning a large purchase but you won’t be able to pay by card.

Currently Virgin Money offers the longest deal at 41 months, charging a 3 per cent handling fee. 

Moving £5,000 from this card would incur handling fees of £150, while this is expensive, it would still cost less than a personal loan charging 3.6 per cent to repay over 3 years. 

A smaller debt of £1,000 added to the Virgin Money card would cost just £36, some £427 less than a loan for the same amount through the market-leading deal from Lending Works. 

This makes it the next cheapest option for those needing slightly longer to repay than offered on the leading purchase credit cards. 

Any other options?  

Many people take out a loan to help consolidate existing debts and fix their monthly repayments.

If you have mounting credit card debt you can shift it to a balance transfer credit card and pay no interest currently for a record 43 months – a deal offered by Halifax.

Again, balance transfer deals are not completely free, you will pay a handling fee to move a balance to the card, most charge between 2 and 4 per cent to do this. 

On a £5,000 debt a 2 per cent fee would set you back £100.

Again you will need to make sure to stick to a repayment plan to make sure you can clear your balance before interest shoots up.  

If you are able to repay within a shorter 24 months, borrowers can find cards which waive handling fees altogether or offer reduced charges. You can read more about these here.  

Should you ever use your overdraft?  

The majority of overdrafts come with a combination of monthly usage fees, overdraft interest or flat rate daily fees. 

Before you consider borrowing through your current account check your terms and conditions and always make sure you have set up an agreed overdraft which will cover the amount you need beforehand.  

As a general rule however you won’t ever want to borrow more than a few hundred pounds through your current account even if it comes with a decent interest-free buffer and it won’t be a good option long-term.  

First Direct offers one of the best accounts for overdraft charges, giving a £250 interest free buffer and charging 15.9 per cent (AER) interest after that.

Both M&S Bank and Lloyds Bank offer slightly less at £100 interest free on their current account and Classic Plus deals.

To put it into perspective however, borrowing £1,000 through the First Direct account would still cost £119.25 over the course of a year.  

Alternatively Nationwide’s FlexDirect account offers a free overdraft for a year. While there is no upper limit you will need to make sure you can pay off any debt within a year, otherwise you risk paying hefty daily fees. 

You can find out more about the best current account overdrafts in our round-up here.