If you are looking to borrow money, an unsecured personal loan can be a convenient and flexible option. Here, we take a look at how personal loans work, who they are best for, and what to look out for.
How do personal loans work?
Personal loans allow you to borrow a fixed amount of money that you pay back over a fixed period. Loan terms are usually between one and five years, although it is possible to borrow for seven years or more.
You can usually borrow any amount from £ 1,000 to £ 15,000, with some providers offering larger loan amounts of up to £ 25,000. Interest rates are usually the most competitive if you borrow £ 7,500 or more.
Personal loans are also called unsecured loans because they are not secured by an asset such as your home.
With a secured loan, if you default on the debt, the lender has the right to take the affected asset and sell it in order to get their money back.
Who are they suitable for?
Personal loans can be a good choice if you are looking to borrow a lump sum to finance a large purchase, such as a home improvement, wedding, or a new car.
They are also worth considering if you are looking to consolidate existing debt in one place with a single monthly repayment so that it is more manageable – and ideally at a lower interest rate.
What are the advantages?
Among the advantages of taking out a personal loan, we can mention:
- Monthly payments are usually fixed, which can make budgeting easier
- You can choose how long you have to repay the borrowed amount, usually up to five years but sometimes longer
- You can usually borrow more money than you could with a credit card or overdraft
- Interest rates can be competitive, especially if you are looking to borrow £ 7,500 or more
- A personal loan can be a great way to consolidate existing debt into one manageable monthly payment with a single provider. Consolidating debt this way can help reduce monthly payments, saving you money.
What are the disadvantages ?
While personal loans have many advantages, there are also a few drawbacks to be aware of. These include:
Higher interest rates for small loans
If you are only looking to borrow a relatively small amount, say £ 2,000, the interest rates can be much higher than if you borrowed £ 7,500 or more. This could prompt you to take out a larger loan than you need – or can afford.
Interest rates can also be higher if you need more time to pay off your loan.
You may not get the advertised interest rate
Loan providers must offer the advertised annual percentage rate (APR) to at least 51% of borrowers, but that also means 49% could be offered a higher rate.
Usually, higher rates are offered to those with lower credit scores, while the best deals are reserved for those with excellent credit scores.
Payments are not flexible
Keep in mind that while fixed loan repayments can help you budget, there is no flexibility, so you will need to make sure that you can afford to pay that amount every month and every month.
If you miss a payment, your provider will usually tell you to make it up the next month, but if you continue to miss payments, the consequences can be more serious.
For example, you may have a “missed payment” recorded on your credit report, which could make it more difficult to access financial products later.
Speak to your lender as soon as possible if you have any concerns about meeting your repayments. Your lender may be able to arrange a repayment holiday or make some other arrangement with you to help you pay off your debt.
Prepayment charges may apply
On the other hand, if you want to prepay your loan, you may need to pay a prepayment charge. This is often the equivalent of one to two months of interest.
You may need to pay arrangement fees
Some personal loans also have an application fee, so be sure to check before you apply. This should be reflected in the APR.
What else should you consider?
If you are considering applying for a personal loan, it is worth checking your credit rating through an online service first. This will give you a good indication of how likely you are to be accepted for the most competitive offers.
If your credit rating is not up to par, you can take steps to improve it, such as:
- Verification of your registration on the list of electors
- Space credit requests at least three months apart, preferably six
- Correct any errors on your credit report or add a correction notice to explain a missed payment
- Pay your bills on time
- Closing unused accounts.
You should also carefully consider the amount you need to borrow. While interest rates may be more competitive on larger loans, remember that it’s important not to borrow more than you can afford to repay.
Also take into account the time you need to pay off your loan and make sure that you will be able to meet your monthly repayments before you apply.
Always do your research before applying for a loan, as interest rates can vary widely from provider to provider.
If you change your mind after you’ve been accepted for a loan, you have a 14-day cooling-off period to cancel after you’ve signed the credit agreement.
If you have already received the funds, you will need to repay them within 30 days.
Bad credit loans
Having a less than perfect credit score can prevent you from taking advantage of the most competitive personal loan rates. But that doesn’t mean you can’t get a personal loan.
There are specialist lenders and types of loans that you may be eligible for if you have a bad credit rating.
For example, guarantor loans involve having your application co-signed by a family member or friend, agreeing to step in if you cannot make your monthly repayments. However, the interest on these types of loans can be more expensive.
The amount you can borrow when you have bad credit is also likely to be lower than someone with a higher credit rating, while the APR you are offered will be higher.
However, if you pay off your loan in full and on time, you can rebuild your credit rating over time.
You can also check your credit score using a credit referral agency such as Equifax or Experian to make sure all information is correct and up to date.
If you find any errors on your report that could lower your score, you can issue a correction notice with the agency to correct things.
What is a secured loan?
A secured loan is secured against your home. This means that if you fail to keep up with your repayments, you might be forced to sell your home to pay off what you owe.
Secured loans often allow you to borrow larger amounts, and because they are less risky for lenders, they can be cheaper than secured loans.
Interest rates can also be variable, so your monthly payments can change at any time.
Are there alternatives to the loan?
If you’re not sure which personal loan is right for you, there are several other options to consider:
0% credit card purchase
This type of credit card can be a good option if you are looking to make a one-time purchase like a new car. It can be cheaper than a personal loan if you only need to borrow a small amount because you can spread your payments over several months without interest.
However, if you do not clear your balance before the 0% is over, the interest will take effect.
0% credit card balance transfer
This type of plastic can be useful for consolidating existing credit card debt. You simply transfer your existing balances and you won’t have to pay interest on that debt for several months. The downsides are that you will usually have to pay a transfer fee and once the 0% period is over you will start paying interest.
0% credit card money transfer
With this type of credit card, you can transfer funds from your card to your bank account. These funds can then be used to pay off existing debts at a lower cost, or to finance unforeseen purchases or bills. Again, there is usually a transfer fee to pay and once the 0% transaction is completed you will pay interest.
Discovered at a lower cost
Some current accounts offer interest-free overdrafts. If you are looking to borrow a small amount over a short period of time, this could be another option. But be aware that interest charges can be high if you go over your overdraft limit, and some interest-free options only last about 12 months, so you’ll need to have paid off your overdraft by then.