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Personal loans are a popular way to borrow. But how do they work, and would one be the best option for you?
Here’s everything you need to know to help you find the right deal.
What is a personal loan?
A personal loan lets you borrow a sum of money that you agree to repay within a set term, as chosen by you. This is reckoned in whole years, but might be described as a number of months by the lender.
For example, a three-year loan might be called a 36-month deal.
Payments are due monthly, and interest will be added on top – usually at a fixed rate for the duration of the loan.
Borrowing amounts are typically between £1,000 and £15,000. But some lenders offer personal loans of up to £25,000. The most competitive interest rates generally apply to borrowing amounts of £7,500 or more.
Personal loan terms are typically between one and five years, although some go up to seven years.
Personal loans are also known as ‘unsecured’ loans.
What’s the difference between an unsecured loan and a secured loan?
Unsecured personal loans are not tied to an asset such as your home or car.
In comparison, ‘secured’ loans require you to use a physical asset with a known value to underpin the debt you are taking on. This means that, if you default on your secured loan, your lender can oblige you to sell your asset to recoup its money.
Secured loans are less risky for the lender because they know that, one way or another, they will get their money back. As a result, you can usually borrow a larger amount over a longer term compared to unsecured loans.
Interest rates can be more favourable too. But secured loans are higher risk for the borrower because their asset is pledged to the lender until the debt is repaid.
What can I use a personal loan for?
Personal loans can be worth considering if:
- you need to borrow a lump sum for a large purchase such as home improvements, a wedding, a trip of a lifetime or a new car
- you’re looking to consolidate existing debts, such as credit cards, store cards and loans, into one place with one monthly payment and one lender.
What are the pros and cons of a personal loan?
Before deciding whether a personal loan is right for you, weigh up the pros and cons below to get a complete picture:about:blank✕
Pros
- Monthly payments are often fixed: This can make it easier to budget as you’ll know exactly how much you need to pay when.
- Borrowing amounts can be more generous: You’ll often be able to borrow more compared to a credit card or overdraft.
- You can choose the loan term: You’ll usually be given a range of options for how long you can repay your loan.
- Existing debts can be consolidated: Debts can be combined into one manageable monthly payment with one lender. If your new loan offers a lower rate of interest, you’ll save money on monthly repayments too.
- Interest rates can be competitive: Particularly on loan amounts of £7,500 or more.
- No collateral is required: Unlike secured loans, personal loans do not require you to use an asset as security.
Cons
- You’ll need a good credit rating to get the best deals: If your credit score is poor, your application could be turned down or you’ll be offered a less favourable interest rate. Loan providers must offer the advertised annual percentage rate (APR) to at least 51% of successful applicants, but the remaining up to 49% could be offered a higher rate.
- Payments are not flexible: You’ll need to commit to making repayments each month until you clear your balance. If you regularly miss payments, this will be recorded on your credit file and you could find it harder to access credit in the future.
- You may face penalties if you don’t make payments: If you miss a payment, you may be charged a fee of perhaps £25. This could be added to your loan and you would thus pay interest on it.
- Interest rates are generally higher for smaller loans: If you’re only looking to borrow around £2,000, interest rates can be more expensive than if you were borrowing £7,500 or more. This could encourage you to borrow more than you need or can afford.
- Early repayment charges can apply: Should you wish to make overpayments or repay your loan early, you may have to pay a fee – this is often the equivalent of one to two months’ interest.
- You may have to pay an arrangement fee: Some lenders charge a fee for setting up the loan, which should be reflected in the APR.
- If you default, you could be given a CCJ: If you do not repay your loan, you could be issued with a County Court Judgment and, in extreme situations, you could be forced into bankruptcy.
Personal loan tips
- If you’ve decided to apply for a loan, keep the following points in mind:
- Only borrow an amount you are confident you can afford to pay back.
- Longer loan terms can reduce your monthly repayments but will also increase the overall cost of your loan.
- Before applying, check your credit rating using a free online service and take steps to improve it if necessary – such as correcting mistakes on your credit report and paying bills on time.
- Once you’ve been accepted for a loan, you have 14 days in which to cancel if you change your mind.
- If you’re struggling to keep up with your monthly repayments, speak to your lender as soon as possible.
What are the alternatives?
There are several alternatives to choosing a personal loan. And, depending on your circumstances, one of them could be a more cost-effective option…
If you only need to borrow a small amount, a 0% purchase credit card could work out cheaper than a loan. This type of plastic allows you to spread the cost of your spending interest-free over several months. Just be sure to clear your balance before the 0% window ends and interest kicks in.
For those with existing credit card or store card debt, a 0% balance transfer credit card lets you shift this debt over and avoid paying interest for several months. There will usually be a transfer fee to pay and, again, interest kicks in once the 0% offer ends.
A further option is a 0% money transfer credit card. These cards enable you to move funds from your credit card directly into your bank account. The funds can then be used to pay off existing debt or to pay for a large purchase. A transfer fee will usually apply, and it’s important to pay off your balance before interest is charged.
Finally, if you only need to borrow a small amount over a short period of time, an interest-free overdraft could do the trick. But interest charges can be high if you exceed your overdraft limit and some interest-free overdrafts are limited to a year, which means you’ll need to pay back the amount borrowed before then.
