Do I need a loan?
If you take out a loan to buy something, it will always cost you more than if you saved up the money and paid for it outright. So the first question to ask yourself is: do you really need to borrow all this money?
Borrowing money is almost always an expensive business and it gobbles up a slice of your income that could be invested elsewhere to build yourself a stronger future.
It goes without saying that, wherever possible, you should aim to borrow as little as possible so you don't overstretch yourself and end up with a bad credit record.
Foolish tip: make sure the monthly payments on the loan are affordable before you agree to take it out.
How does a loan work?
If you take out a loan, every month you will make a payment to the lender. Part of the money you pay will go towards repaying some of the debt you borrowed and part of it will go towards paying off the interest you owe on that debt. This will continue until you have cleared the debt.
Foolish warning: the longer you take to pay a loan off, the more it will cost overall. This is because you will end up paying interest on your debt for longer.
How long does a loan last?
The length of a loan can vary widely, according to your needs. But typically they last from three to 10 years. You choose how long you want your loan to last based on how much you need to borrow and how much you can afford to pay back every month.
Play around with some figures using our loan calculator and work out the level of monthly payments that you can afford. Remember: the shorter the term of the loan, the larger the monthly payments – but, overall, you will end up paying less interest.
Foolish warning: the language some lenders use can be deceptive. Be careful of illustrations such as '£15,000 over 60 months at £322 a month' when 60 months is, er, five years. Lenders describe loan terms in months rather than years because it makes the loan term sound shorter.
What are the different types of loans?
There are two types of personal loan: the unsecured loan and the secured loan. So let's take a look at what they are:
Unsecured loans allow you to borrow money without giving your lender security (such as your home or your car) against the loan. In other words you are less likely to lose your home or your car if you can't keep up with your loan repayments. However, it is possible, sometimes, for lenders to force the sale of your property or to get it repossessed by applying to the court, even if you have an unsecured loan.
These days, many borrowers can get a pretty hefty loan if they want. The maximum amount you can borrow using an unsecured loan is £25,000, although some lenders have lower limits.
Unsecured loans usually have fixed interest rates. That means you'll know exactly how much you have to repay each month regardless of any changes to interest rates in the wider market.
Secured loans are riskier than unsecured loans. This is because, with a secured loan, the lender secures its loan against an asset you own, usually your house. This means that, if you fail to pay back a secured loan, the lender can take possession of that asset more easily than with unsecured loans.
You are often able to borrow more money with a secured loan than you can with an unsecured loan.
Secured loans usually have variable interest rates. This means the amount of interest you have to pay may go up or down over the course of the loan term, which means your monthly payments will vary too.
A mortgage is a type of secured loan, but it's often cheaper than other secured loans and frequently, these days, you can fix the interest for an agreed period. You can also swap your debt relatively easily between lenders, but watch out for early-redemption penalties and exit fees.
What is APR and why do I need to know it?
APR stands for Annual Percentage Rate. When you borrow money, this rate should always be quoted to you. It's the interest rate which your loan will cost you each year, including all charges.
Often, banks quote a ‘typical APR'. Don't be fooled into thinking you will be automatically offered this rate. Legally, the lender only has to offer this rate to 66% of its customers. If you have a poor credit record or don't fit the profile the lender wants, you may not be able to secure this rate or, indeed, any rate at all.
The average APR for a competitive personal loan is usually less than 5% above the Bank of England Base Rate. You can compare the most competitive deals currently available in our loans comparison table.
Foolish warning: APRs can give you a rough sketch of the cost of the loan, but bear in mind that they can be manipulated in complex ways by banks (for example, by offering you a repayment holiday during the first year) to make them appear less costly than they actually are. That's why we believe the best way to compare loans is to look at the TAR, Total Amount Repayable.
What is TAR and is it important?
TAR stands for Total Amount Repayable. The TAR is the total amount you will pay back over the term of the loan, including all interest and compulsory fees.
TAR makes it quite simple to compare the costs of different loans. Once you have worked out the TAR of each loan, you can easily decide which one is cheapest overall, and therefore which one you want to go for.
Foolish tip: always find out the TAR, as well the APR, of any loan.
Who gets what rate?
The rate you are offered by a lender will depend on your credit record.
If you have always paid your bills on time and have a spotless credit record, you should qualify for cheaper rates than if you have a history of bad credit. This is because you will be viewed as a higher-risk applicant if you have failed to promptly pay back what you have borrowed in the past.
Foolish tip: you can review your credit history before you apply for credit by taking out a free 30-day trial of CreditExpert from Experian. This will allow you unlimited access to your Experian credit report, and it's free if you cancel your membership within 30 days.
What does ‘consolidating debt' mean and do I need to do it?
‘Consolidating debt' means merging all your various debts (on your credit cards, store cards and other loans, for example) into one place, with one lender, charged at one rate.
If you owe a large debt on credit cards or store cards, you may wish to consider consolidating your debt into one personal loan. This is because the typical interest rate charged on a credit card is likely to be at least twice as high as the rate charged on a loan.
By cutting the interest rate in half, you will dramatically reduce the amount of interest you will have to pay on your debt, and that means you should be able to pay it off more quickly.
Consolidating your debt could also make your life easier, as you'd only be making one payment each month.
However, and this is a big ‘however', consolidation is only suitable for a small number of people. We've found that people who consolidate debts usually go on to run up more debts on their now cleared credit cards. Furthermore, there is often a cheaper solution, such as throwing your spare cash at paying off your most expensive debt (i.e. the one with the highest interest rate) first, then moving onto the next most expensive.
Foolish warning: think twice before you consolidate unsecured debts, such as credit-card debts, into a secured loan or mortgage. It can work out OK, but bear in mind you are putting your home at risk.
What happens if I take out a loan and don't pay it off?
To some extent, this depends on whether you have taken out a secured loan or an unsecured loan.
If you have taken out a secured loan, your home is more likely to be repossessed if you fail to pay it back.
If you have taken out a secured or unsecured loan you cannot pay back, or have credit-card debts you can't meet, you could be pursued through the courts for the repayment, and could receive a County Court Judgment (CCJ) against your name.
This will seriously damage your credit rating; for example, it will mean that, in the future, mortgage lenders will charge you a higher rate if you want to take out a mortgage. You also may find it more difficult to get a credit card or a loan.
Even if you have an unsecured loan or credit 5card, your creditor may be able to secure a Charging Order against your property. This means that when your property is sold your debt will have to be paid before you can receive any money from the sale.
What's more, if a Charging Order is granted, your creditor may then apply to the court for an Order for Sale. If this is granted, then the procedure works just as if you had taken out a secured loan and were having your home repossessed -- the house will be sold, the creditor gets his money and you're homeless. Alternatively, the judge may decide to give you enough time to sell the property yourself.
Foolish tip: check how much your monthly payments will be before you borrow any money – and don't borrow more than you can afford to pay back. Bear in mind with variable-rate loans that your payments might go up...Could you still afford it if they did?
What are the alternatives to a loan?
A loan is not your only option. There is another way to get hold of credit: take out a 0% credit card. Many credit-card lenders nowadays offer an introductory rate of 0% interest on new purchases for a set period, typically three to 12 months, when you take out a new card. This means you will not pay any interest on new purchases during this period.
However, you may have to pay interest on any balance you have transferred to that card, unless you look for one that offers 0% on balance transfers as well. What's more, 0% balance transfers usually cost a fee of 2-3% these days, so you'll need to be prepared for that as well.
Remember, you are only delaying the inevitable by taking out this card. At some point you will have to pay off your debt. Still, a 0% transfer deal means you can throw money purely at your debt and not waste it on interest payments.
Foolish warning: once the introductory rate runs out, you will have to pay interest at the standard rate associated with that card. This is likely to be very high, so plan ahead. Ideally, you would want to make sure you have enough money set aside to pay off the debt in full once the 0% deal ends.
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