What are the differences between loans and other forms of borrowing?
A loan is a fixed cash lump sum from a lender that you pay back, with interest, over a set time.
Some loans are for specific purposes, like mortgages for a property, or student loans for your studies. Personal loans can be spent however you wish.
You usually cannot 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 use your savings if you have them.
Other forms of borrowing include credit cards and store cards. These do not give you cash but instead give you credit, which you must pay back each month.
Depending on the type of credit card you have, you can continue to spend on them while you are paying them off. But they have a set limit that you cannot 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 will 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 do not 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 will repossess your car if you do not 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 £100,000 with a secured loan.
Unsecured loans do not 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
- Bad credit loans
- Guarantor loans
Rates vary between different loan types, so it’s important to know what your looking for when you compare loans.
The loan type does not solely influence the best loan rates.
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.
A personal loan is 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 cannot pay what you owe.
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.
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 if you do not have the cash to buy it outright. 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 low cost unsecured loans that you use to pay off any higher cost debt you already have.
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 expensive 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 cannot 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?
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.
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% and should be avoided where possible.
2. Repayment period
Repayment periods for unsecured personal loans are usually between 1 and 7 years. The can be longer for secured loans. For example, the average 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, but there’s a risk they could go up 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 are most likely to be accepted for before you apply. They only do a ‘soft search’ on your credit file which does not show up on your credit file and so does not impact your score.
What happens if you’re turned down for a loan?
You may be turned down for a loan if you have poor credit. You may be accepted for a bad credit personal loan, but there is no guarantee.
It’s 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 go directly into your account. You then repay the loan in monthly instalments for the course of the agreed term.
There is 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.