By Matt Fernell, Editor-in-Chief at Finance.co.uk. Published 6th December 2023.
An unsecured personal loan is a way of borrowing a lump sum of money that you repay over an agreed period. Here’s everything you need to know about how they work.
An unsecured personal loan is where you borrow money from a lender and repay it back in monthly instalments, typically lasting between twelve months and seven years. When repaying your loan, you'll pay interest and any additional fees on top of the money you’ve borrowed.
How much you can borrow will depend on your affordability and credit history. Personal loans can range from £1,000 up to £25,000, although some providers on the market will lend you as much as £50,000.
Unsecured personal loans typically come with higher rates of interest compared to secured loans, making them more expensive, especially if you're repaying over a long period.
The money you borrow can be used for anything you need it for, such as:
Repaying family and friends
Some loans can be used for small business purposes; however, providers may have restrictions against this. It’s always best to check the terms and conditions if you want to use the loan to pay for business expenses.
The amount you can borrow will depend on your affordability. When looking at your application, loan lenders will review your income and any regular outgoings, like rent and bills. If you have a low income and a lot of regular expensive outgoings to pay, you may find lenders will only let you borrow a small amount of money.
For many personal loans, the most you can borrow is around £25,000, but some lenders may have a higher limit if you have a good credit rating.
A credit rating is an evaluation of your creditworthiness - scoring you on how likely you are to manage and repay a loan properly. Three main credit reference agencies in the UK give you a unique credit score: Experian, Equifax, and TransUnion.
A good credit score for each is:
Between 881-960 out of 999 for Experian
Between 420-465 out of 700 for Equifax
Between 604-627 out of 710 for TransUnion
It's unlikely you'll find personal loans offering more than £50,000 because they are unsecured, meaning lending larger amounts is risky for loan companies.
How much your loan will cost you will depend on:
The total amount borrowed
The interest rate of the loan
Any additional fees and charges
To keep the cost of your borrowing down, it's important you borrow only what you need. It can be tempting to borrow more if you’re offered a large loan, but remember that it’s a big commitment and the more you borrow, the longer it will take you to pay back and the more expensive it will be.
The interest rate of a loan is usually displayed as APR (annual percentage rate). This percentage includes the rate of interest and any fees you'll have to pay. The lower the APR, the less interest you'll have to pay back.
For example, if you borrow £1,000 at 10% APR over one year, you’ll repay £1,100 overall. The same loan with a 15% APR will cost £1,150, so it pays to find the lowest rate possible.
Fees and charges can also make your loan more expensive, and there are multiple that you could have to pay. Some of the common fees are:
Arrangement fee: Some lenders charge This admin fee for arranging your loan. The average cost is around £20.
Late payment fees: You’ll have to pay this fee if you miss a loan repayment. For most loans, this fee can be around £15 or more; however, you’re also likely to be charged interest on the overdue amount.
Early repayment fee: You’ll have to pay this if you repay your loan early. The amount you pay will likely be a percentage of the amount you’ve borrowed.
With all this to think about, working out the cost of your loan can be tricky. To find the best value for money, make sure you compare APR, interest rates, and the total amount you have to repay. There are many loan cost calculators online to help you determine which loan is right for you.
Not paying a personal loan can lead to serious consequences. It will harm your credit rating, and the worst-case scenario could see your personal items repossessed.
If you haven’t enough money in your bank account to afford your repayments, the lender will still try to withdraw the funds due. You may be charged £15 for each failed attempt.
A missed payment will also harm your credit rating. You could negotiate with a lender to change when you’re due to pay, giving yourself more time to get the money together.
When you miss a repayment, you’ll default on your loan. Once you default, your lender will try to contact you to make a repayment.
If you're still unable to pay, the lender may sell your unsecured debt to a debt collection agency, which will likely bombard you with calls and letters to get you to pay.
Eventually, the lender may issue a CCJ (County Court Judgement) and take you to court. A CCJ is recorded on your credit report and will negatively affect your credit rating.
If you're still unable to repay the loan after a CCJ, the lender can obtain a warrant and employ bailiffs to collect your personal items to be used to repay the debt.
Loan providers use your credit rating to see if you meet their loan eligibility criteria. You'll be approved for most loans with at least a moderate credit rating. However, you'll need a good credit rating to get low-interest deals.
If you have a poor credit score, your application for a personal loan may be rejected. If not, you may not be offered the best terms, making your loan more expensive.
To help you get the best personal loan possible, you can boost your credit rating by:
Signing up to vote if you haven't already
Keeping your details up to date on your credit report
Only using up to 30% of your credit limit on any credit cards
Paying off any existing debt you have
Keeping current accounts and credit cards open to build a long credit history
Keeping up with repayments on current credit products
Here is more information on how bad credit loans work, and if you can get one.
A personal loan isn’t the only way to borrow money if you need to. What type of borrowing is right for you will depend on how much you need to borrow, your financial situation and what you need the money for. Some alternatives to unsecured loans include:
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.