Personal loans explained
Whether you're looking to consolidate debts, buy a new car, fund your dream wedding or
honeymoon or even buy a piece of artwork, then a personal loan could provide the cash
influx that you need.
What are personal loans and how do they work?
A personal loan is usually an unsecured loan; this means that you can borrow money
without providing the lender with security - such as your home or your car. Although
you're not providing the lender with any security, you are still obligated to
meet your repayments on time and in full. If you miss repayments it may have a
negative effect on your credit rating and could potentially result in a County
Court Judgment (CCJ) being filed against you or even a lender passing your details
onto a debt collector.
Personal loans are typically available in amounts ranging from £500 up to a
maximum of around £15,000, although some lenders may offer more than this. The
exact terms will depend on the individual lender. If you do want to borrow more
than this you may find that a
secured loan
(also called a homeowner loan) is a better option.
When you take out a personal loan you will sign a credit agreement that outlines the
amount borrowed, the interest rate, the amount of interest charged and the total amount
repayable. It will also state your repayment terms i.e. your monthly payment along with
the term of the loan, in years and months. Personal loans are usually based over a term
of between 6 months to 10 years although most lenders will have a maximum term of
between 5 and 7 years. Remember that the repayment term will have a direct impact on
the total amount repayable and the amount of interest charged i.e. the longer the
repayment term, the higher the total amount repayable will be.
The interest charged is often the key to finding a good personal loan deal. The lower
the interest rate, the less you may have to pay on top of the original amount borrowed.
The interest is shown as the APR (Annual Percentage Rate), although lenders must
generally advertise a “Typical APR”, which is the rate that at least 66 percent
of successful applicants must qualify for.
This does of course leave another 34 per cent of applicants who will be offered a different
rate to the “headline” or “advertised” typical rate. This decision may
be based on a process called “risk based pricing” in which a lender can make a
judgment about your ability to meet repayments - in simple terms, those less likely to
default are likely to be offered better rates. This judgment may be based on your credit
profile and can be affected by factors such as your employment status, how long you have
lived at your address, whether you are a home owner, whether you appear on the electoral
roll and your payment history.
Broadly, there are two types of personal loans to choose from:
You pay a fixed amount every month throughout the term of the loan, giving
you peace of mind and the ability to budget your outgoings.
The interest rate you pay may fluctuate dependent on the Bank of England base rate
or market forces. This means that your monthly repayments and the total amount you
repay over the term could increase or decrease. If interest rates go up, you could
repay a lot more than you originally budgeted for or, worse case scenario, be unable
to meet your repayments.
What should you look out for when taking out a personal loan?
There are many additional factors to consider when taking out a personal loan:
Many personal loans have strict eligibility terms such as age (usually you
must be 21-65) and residency. In most cases you must be a UK resident
for at least three years and have a current account and a regular income.
Some lenders will charge a penalty if you repay the loan early (because they will
not be earning the interest they expected). This fee can vary, but is usually
equivalent to one or two months’ interest depending on how much notice you give.
Check the terms and conditions thoroughly for other fees, such as arrangement fees.
- Payment protection insurance (PPI)
This is an insurance product that can help cover your repayments if you can't
work due to an accident, illness or involuntary unemployment. It can be beneficial
but can be expensive when sold alongside a loan. It is not compulsory and you may
prefer to shop around for a stand-alone deal. Always check you are eligible for any
cover offered before you accept it.
- The availability of funds
Lenders may charge a fee for same day transfers. With normal transfers (usually
two-three working days) you can usually avoid this fee.
- Payment breaks/deferment periods
Some lenders offer “payment holidays”. While these can be beneficial if
finances are tight, bear in mind that interest will continue to be charged meaning
that your total amount repayable will increase.
Who are personal loans right for?
Some people choose personal loans for the purposes of debt consolidation i.e. to pay off
all their outstanding debts, such as credit cards, store cards and hire purchase agreements.
By consolidating your debts into a personal loan, you could reduce the amount you repay
each month, or you could control the length of time over which you will clear your debts.
Reducing the amount you spend repaying your debts each month may mean that you repay
the total debt over a longer period - so always remember that this option can cost you
more in the long run.
Before you take out a personal loan consider whether there are other options available
that may suit your individual circumstances better. Think carefully about your ability
to repay the debt should your circumstances change and remember that if you're using
your loan to buy a car, the depreciation of the vehicle may occur at a greater rate
than that at which you reduce your debt - therefore, if you do need to sell the vehicle
to repay the loan you may end up owing more than the vehicle is worth.
Remember to shop around for a personal loan in order to find the best loan rate. Compare
rates and terms, as even if a loan has a low APR you may end up paying more than you
would do with a slightly higher APR as there may be other considerations to take into
account. Don't make random applications - if you have a bad credit rating the
best interest rates are unlikely to be available to you and rejections could harm
your credit rating.
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