Edited: June 16, 2021
How personal loans and other sorts of borrowing work
A loan is a fixed cash lump sum from a lender that you pay back, with interest, over a set time. Using the Uswitch loan comparison tool, you can find the best loan for you.
Some loans are for specific purposes, like mortgages for a property, or car finance for a vehicle. Personal loans can be spent however you wish. Compared with high interest overdrafts or credit cards, these loans can be cheaper if you're unable to pay the money back quickly, so they could be one of the best finance options. You will be responsible for repaying the amount you have borrowed, as well as any interest and other fees charged by the lender.
You usually can't borrow more money on your loan during the repayment period. To borrow more money, you could take out another loan, use a credit card or overdraft.
The term of the loan is fixed, meaning if you want to pay off the loan early, you can be charged a fee.
Other forms of borrowing include credit cards and store cards. These generally don't give you cash when you take them out, but instead give you credit, which you must pay back some of each month.
Depending on the type of credit card you have, you can continue to spend on them while you're paying them off. But they have a set limit that you can't exceed, and you should only ever spend what you can comfortably afford to pay back.
What are the different types of loans?
The two main types of loan are:
Secured loans are where the debt is tied to an asset. If you’re unable to repay the loan, the lender can repossess the asset to offset the payment.
A mortgage is an example of a secured loan with the property as the ‘security’. So, if you don't meet your repayments, the mortgage lender can take your house.
Car finance is another type of secured loan. The loan is secured against the vehicle, so the lender can repossess your car if you don't keep up with the repayments.
Secured loans are often used for long term borrowing, some for up to 40 years. While this may make your monthly instalments more affordable, it drives up the lifetime cost of the loan because of the interest.
You may be able to borrow from £3,000 up to £500,000 with a secured loan. You are likely to receive a cheaper rate of interest for a secured loan compared with an unsecured loan, as the lender has more 'security' they will be repaid.
Unsecured loans don't require you to provide extra security to the lender. Your credit rating and financial situation are two of the biggest influencing factors for lenders to consider.
The following are different examples of unsecured loans:
- Personal loans
- Car loans
- Debt consolidation loans
- Bad credit loans
- Guarantor loans
Rates vary between different loan types, so it’s important to know what you're looking for when you compare loans.
The loan type isn't the only influence the interest rates charged.
The cheapest loan rate available to you also depends on your credit history, the size of the loan and how much you can afford to pay back each month. In general, the interest rate charged on an unsecured loan will usually be higher than for a secured loan as there is less security the lender will be repaid the amount owed.
A personal loan are a type of unsecured loan, usually between £1,000 and £25,000. The repayment term can be from 1 to 7 years.
This means a lender will not ask you to sign over the right to an asset if you can't pay what you owe. However, missing payments or defaulting on the loan can impact your credit score and ultimatrely result in county court judgements against you.
You can spend an unsecured personal loan in any way and on whatever you want.
Car loans are unsecured personal loans that you can use to buy a car outright. This means if the car is sold, written off or stolen inside the terms of the loan you will still have to keep making loan payments until the debt is cleared. Conversely, failingto keep up payments will not directly result in the reposession of your car.
Car loans are a different to car finance, which is secured against the vehicle you bought.
Car finance is a secured loan for the purchase of a vehicle.
One of the most common types of car loan is known as personal contract purchase, or PCP.
Most car dealerships offer some type of car finance option available. To get a clear idea of the cheapest loan rates, it’s worth doing a loan comparison before you go to the car dealership.
Debt consolidation loans are unsecured loans that you use to pay off any higher cost debt you already have. For example, you could take out a loan to pay off your overdraft and credit card debts.
They can help you reduce your monthly repayments, cut down interest charges, and make it easier to manage your finances.
But debt consolidation loans tend to have long terms. This means it could take you longer to repay and therefore pay more overall.
Bad credit loans
Personal loans for bad credit are unsecured loans for those with a problematic credit history.
Even the cheap interest loans for bad credit are relatively expensive compared to a standard loan because the lender has no security and may be concerned you will not repay what you owe.
You could have a bad credit score for any number of reasons, including:
- Having no credit history because you’ve never had credit before, or are from overseas
- Missing or defaulting on payments
- Not being on the electoral register
Guarantor loans enable those with a bad credit score to borrow money by naming a family member or close friend as a guarantor. The person you choose is liable to repay the loan on your behalf if you can't repay it.
Guarantor loans are technically unsecured, but the guarantor and their assets (they must have at least 50% equity in their property if they own one) do act as security.
What should you look out for when you compare loans?
It's important to compare loans to make sure that you are getting the best deal on the market for you.
Things to look out for when doing a loan comparison include:
- The Repayment period
- Fixed or variable rate
- Application time
1. APR (Annual Percentage Rate)
To find the best loan deals, the APR (annual percentage rate) is one of the most important things to look at.
The APR includes the interest and any extra charges like set up fees. The higher the APR, the higher your repayments for the same loan size.
Bad credit loans and guarantor loans have higher APRs than normal personal loans. This makes them an expensive way to borrow money.
Payday loans have the highest APR, often over 1,000%, but over a short period and for realtively small amounts of money. That means they are very rarely suitable for larger projects and more expensive than many other types of borrowing.
2. Repayment period
Repayment periods for unsecured personal loans are usually between 1 and 7 years. They can be longer for secured loans. For example, the average initial mortgage term is 25 years.
Loans over longer periods have lower monthly repayments. But the longer your take to repay your loan the more it will cost you because of the interest.
3. Fixed or variable rate
Check to see if the interest rate on your loan is fixed or variable. If you prefer to know exactly how much you need to pay each month, a fixed rate loan may be better for you.
Variable rates may be cheaper at first, but there’s a risk they could go up in price at any time and at the lender’s discretion.
4. Application time
the time it takes a lender to process your loan application varies. It’s usually anything from 24 hours to 1 week. It may be longer if there are problems with your application.
Eligibility checkers show you which loans you're most likely to be accepted for before you apply. They only do a ‘soft search’ on your credit file, which doesn't show up on your credit file to lenders and so doesn't impact your creditworthiness. A hard search - typically made when you apply for a loan - is visible to other lenders. This could impact the rates you are offered or see you rejected outright if there are a lot of them made in a short space of time, as it can make you seem desperate for money.
What happens if you’re turned down for a loan?
You may be turned down for a loan if you do not meet the lender's criteria or have a poor credit history. In these cases you may still be accepted for a bad credit personal loan, but there's no guarantee.
Its good practice to always check your credit report before you apply for a loan. It gives you the opportunity to check for errors and avoid applying for loans you’ll likely be rejected for.
A rejected application could further damage your credit file and your score.
You can apply for a more suitable loan if you’ve previously been rejected for a different one. But lots of applications in a short space of time will look bad on your credit report.
A guarantor loan may be an option if you cannot get a loan on your own.
Another alternative to a loan is a credit card. Like with loans, there are special credit cards for those with bad credit.
Do what you can to pay off existing debts and minimise your outgoings. Of course, this may not always be possible.
If you are in real financial difficulty, a loan will only add to your debts. Debt charities like Step Change or Citizens Advice can help you sort your finances
What happens when you’re approved for a loan?
When you’re approved for a loan, the money should be paid directly into your nominated account. You then repay the loan in monthly instalments for the course of the agreed term.
There's usually a 14-day cooling-off period, during which you can cancel the loan if you change your mind about it. But you must repay the full amount to avoid penalties.