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By Laura Rettie, Personal Finance Journalist.
The choice of different loans available can leave borrowers feeling overwhelmed. We’ll help you to understand how a loan works, the different types of loans available to you and what you should know before applying for one.
If your loan is approved, you’ll recieve the money via your bank account and pay it back in monthly installments. You’ll either borrow money as an unsecured or secured loan and there are some key differences in how they work.
Unsecured loans are not secured against any asset such as your home. The interest rate is fixed and repayments are made monthly.
You can control how long you’d like to repay the loan, but the longer you take to repay it, the more interest you’ll pay. The typical repayment term for an unsecured loan is between one and 10 years.
They’re a good option if you have a good credit score and regular income.
This type of loan is secured against your home or a property you own. The equity is used as collateral, which means that if you cannot make the repayments, the equity in your property will be used to cover the debt.
Secured loans are usually used by people who need to borrow more than £10,000 for up to 30 years, so if you only want to borrow short term or a small amount, a secured loan may not be your best option.
Interest rates are often lower than personal loans or credit cards and it’s an option worth considering if your credit score is low.
You’ll need to carefully consider the benefits and drawbacks of a secured loan because your home is at risk if you cannot keep up with repayments.
There‘s a wide range of loans to choose from, tailored to different purposes, budgets, and timeframes. While certain types of loans are more affordable than others, securing the best interest rates usually requires a good credit history. Here are the primary loan types offered by banks, online loan companies, and money lenders.
A personal loan is a standard loan from a bank, building society or money lender. You don’t need to provide collateral and terms of repayment tend to be more flexible. However, if you’re looking to borrow a large amount this could be a costly option and mean high monthly repayments.
You can use a personal loan for any purpose, such as buying a car, going on holiday or to help fund a wedding.
Secured loans can also be known as homeowner loans or second-charge mortgages.
This type of loan is secured against an asset you own. In most cases, this is your home or a property that you have a stake in.
The equity in your property is used as collateral, which means if you can’t make the repayments, the equity in your property will be used to cover the debt.
Some lenders offer large unsecured loans specifically for home improvements. Typically, home improvement loans allow you to borrow up to £25,000 and repay the money you’ve borrowed over a set period. You will need a good credit rating to get approval for this type of unsecured loan.
Some home improvement loans are secured loans, which are a better option for long-term borrowing or large amounts. Here's how home improvement loans work.
Car loans are unsecured loans used to finance a car purchase. They’re used as an alternative to other car financing options such as Hire Purchase or Personal Contract Purchase (PCP).
A car loan is a good option if you want to own your car outright and spread the cost of payment without getting tied down by a contract.
These are bank loans designed for people with a poor credit history and existing bad debts. They’re the same as a personal loan but are offered by specialist money lenders with high-interest rates.
An online lender may accept your application even if you have bad credit, but the interest rate will be higher because of the risk you may default on repayments.
Guarantor loans are a type of unsecured loan where someone else (usually a close friend or family member) guarantees that the loan repayments will be made if you can’t make your repayments. They will need to undergo affordability and credit checks but the loan terms will be the same as a personal loan.
If you’re seeking a secured loan to pay off other debts, a debt consolidation loan allows you to borrow money to pay off multiple debts, e.g. credit cards, store cards, and overdrafts, which you then pay back in one monthly repayment.
If you’re struggling to keep track of what you owe, consolidating your debts can be a helpful way to regain control of your finances and rebuild your credit score.
Taking out a loan can be a great way to solve short term cashflow or spread the cost of a large purchase. Borrowing money can be risky if you’re not aware of the pitfalls. It’s important you understand what happens if you’re late repaying, miss a payment or can’t pay back the money you owe.
Unsecured personal loans depend on your ability to repay on time and within the loan term. If you can’t keep up your commitments to the lender you risk:
Secured loans come with additional risks - although a secured loan can be a good way to use the equity in your home to release extra funds, it’s very important you understand the potential dangers.
Put simply, if you cannot make repayments on your secured loan, your house could be repossessed.
Getting a loan will not adversely affect your credit rating if you don’t miss any repayments and always pay them on time.
In fact, a personal loan could help you to build your credit score and get credit in the future if you can prove you’re a reliable borrower with regular, on-time payments.
This will depend on several factors, such as:
If you’re planning to take an unsecured loan, lenders look at your income and employment status to assess your repayment capacity. If you have a regular, good income, you’ll likely be able to borrow the maximum amount offered and the interest rate will be favourable.
Lenders use your credit history to determine how much of a risk they are taking by lending to you. Your chance of approval and rate of interest will depend on your credit rating and ability to repay.
If you’ve previously defaulted on a loan or missed payments on credit cards and mobile phone bills, you may have a poor credit rating.
The maximum you can typically borrow as an unsecured or personal loan is around £30,000. Whether your lender agrees to that amount will depend on your income and credit history.
Lenders will usually offer secured loans up to £500,000, though this will depend on how much equity you have in your home and how much you’ll be able to repay each month.
A loan can be useful if you’re looking to spread the cost of significant purchases or to fund major projects; they’re often a cheaper alternative to credit cards or other types of borrowing.
The best loan companies offer low interest rates with flexible payment options, and as long as you stick to your repayment terms, a loan can be a low risk borrowing method.
A loan can help you:
Whilst there are some advantages to taking out a loan, it’s always worth weighing up the pros and cons. Here’s some of the pitfalls to watch for:
Only take a loan as a last option. If you can afford to pay for purchases or projects with cash or savings, you might be better off choosing those methods of payment over a loan.
Cheap loans are not always the best loans - if you want to borrow money online it’s good to know what to look for.
Make sure you understand the overall costs of the loan; the total amount payable could end up being more than you think. Interest and other fees will always make borrowing to finance purchases or services more expensive.
The lower the interest rate, the cheaper your loan will be, although you may not get the advertised rate. Our loan comparisons will include the typical APR (Annual Percentage Rate) for each lender, helping you get an idea of the cost of the loan before you apply. .
Borrowing over a shorter period of time will generally help to reduce the overall cost of your loan, but you’ll need to make sure you balance keeping the total cost down with being able to afford the monthly repayments.
Check for early repayment fees and other charges for late payments, missed payments and arrangement fees. Be sure to check the small print and check for any changes that could occur during the loan period.
Check your credit score regularly and work on building it. A low credit score may make lenders less willing to offer you a personal loan. Having a poor credit score may also mean that if you’re offered a loan, the interest rates offered will be higher than if you had a good credit score, making it more expensive for you to borrow money.
However tempting it may be, don’t be tempted to borrow more than you need.
Read more about different types of loans; guarantor loans, car loans and home improvement loans
The information provided does not constitute financial advice, it’s always important to do your own research to ensure a financial product is right for your circumstances. If you’re unsure you should contact an independent financial advisor.
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We're on a mission to improve the finances of the nation by helping you to spend wisely and save money
If you have a change in your financial situation and think you’re going to struggle to repay your personal loan, contact your lender immediately. They may be able to arrange a repayment break, but check it doesn’t affect your credit score.
Your payments will still accrue and you will need to repay the deferred payments including interest when the repayment break is over. This means that you may pay a higher amount per month than before the holiday period.
Yes, you can, but you’re likely to pay higher interest rates, which means your loan will be more expensive. Banks are more reluctant to lend to people with bad credit, but there are many specialist money lenders who may be able to help.
A good first step to getting a loan with bad credit is to check your credit score and work on repairing it so you can get better credit facilities in future.
It depends on how much you borrow and how long for.
Credit cards allow you to borrow to a set limit that will depend on your credit score.
A 0% purchase credit card or balance transfer card used wisely can be a cheaper option than a loan for borrowing smaller amounts of money for a short amount of time. Credit cards can also be more flexible if you want to repay early.
It’s money you can borrow from a bank, building society or direct lender that you pay back over an agreed period of time with interest. There are two ways you can borrow money:
For most loans, how you choose to spend the money is up to you - popular reasons for borrowing include:
Some loans offering low interest rates may require you to use the money for specific purposes, such as home improvements for example.
There are several options when it comes to applying for a loan, such as:
If you’re unsure about which loan is right for your circumstances, you may benefit from talking through your options, so applying over the phone or at a branch could be a good idea. However, if you know what you’re looking for and have a clear idea of your borrowing needs, you may get the best deal by applying online.
This will depend on where you get a loan. If you apply with your current bank, it’s best to check with them before your loan application.
If you apply with another lender, more loan eligibility checks may need to take place.
It’s likely you’ll need to provide the following documents:
You may need to meet other eligibility criteria set by the lender. You’ll also need to have a current account that allows you to set up a direct debit or standing order.
All lenders will have different eligibility criteria, but generally, you must be:
