Taking the time to read the small print on a loan for a new car or kitchen is not easy. After all, you also have colour schemes and optional extras to think about.

But failing to check if your loan agreement includes pricey payment protection insurance (PPI) could be costly in the long run. Many lenders include PPI, which is designed to cover repayments if you fall ill or lose your job, in personal loan quotes, whether customers want it or not.

The problem is that the PPI offered by many lenders is far more expensive than the standalone policies that are available. The problem of PPI has become so severe that many borrowers are now applying to the Financial Ombudsman Service for refunds because they did not explicitly agree to the PPI premiums added to the cost of their loans. Research by Which? Money, the consumer magazine, found that more than half of a sample of 41 quotes given over the telephone by high street lenders included PPI automatically.

Ian Allison, of Conkers. com, a PPI claims service, says: “Many people buy PPI without being aware of it. When they take out a loan, PPI is bundled into the premium. Those who query PPI may be given the impression that they will not be granted the loan without it.”

Of the seven million people a year who take out PPI, only 4 per cent make a claim on the policy. A quarter of these are rejected. The Office of Fair Trading says that the value of claims paid out is only 20 per cent of the total premiums, compared with 82 per cent on car cover and 54 per cent on household policies.

The Financial Services Authority (FSA) fined a number of lenders recently, including Capital One and GE Capital Bank, for mis-selling PPI and is involved in a programme to improve standards. The Competition Commission is also looking at how this insurance is sold, but it is not due to publish its findings until next year.

One reason for the high cost of PPI is that it usually has to be paid as a single premium, which is added to the loan upfront. The cost of insuring a £5,000 loan over four years varied from nearly £600 with Leeds Building Society to £1,997 with Great Universal, according to Defaqto, the financial research company.

Furthermore, those who pay off loans early are often unable to obtain a refund of the insurance premium for the outstanding term. In March the FSA agreed with the industry that nil-refund clauses would be abolished and refunds should be calculated “fairly”.

A cheaper option is to pay for PPI monthly. This is how standalone policies work. Brian Brown, of Defaqto, suggests that you shop around with providers such as the Post Office, AntInsurance and British Insurance.

However, PPI will not cover preexisting medical conditions, or unemployment if you are self-employed or have heard rumours of a takeover of your company. Even when they are paid, PPI benefits normally last for only 12 months, so if your employer has a good sick-pay scheme, or you have adequate savings, you may not need insurance. For longer-term cover consider income protection insurance instead.

How to complain

If you feel that you have been mis-sold PPI, you may be able to claim a refund or compensation.

Write to the provider of your loan saying why you believe that you were mis-sold. If you do not receive a satisfactory reply in a reasonable time, say six weeks, contact the Financial Ombudsman Service on 0845 0801800, or online at www.financial-ombudsman. org.uk. Complaints can be taken to the ombudsman up to six years after you took out the insurance.

Claims-handling services take a slice of any money you receive. Conkers.com takes 25 per cent.

CASE STUDY: Horticulturist cuts charge down to size

GIiselle Fox, a self-employed horticulturalist, from Braintree, Essex, bought PPI to cover a car loan, but at a fraction of the price she would have paid her lender for the insurance.

The 25-year-old says: “Last September I needed to buy a more reliable car for my work. I took out a £5,000 loan with Nationwide over three years, costing £170 a month. As I am self-employed, I wanted PPI to cover me against accident and sickness, but Nationwide was going to charge me an extra £40 a month. A friend told me about British Insurance so I took out one of its policies, which costs me only £3.50 a month.”

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