Loans


What is a personal loan?

A personal loan, otherwise known as an unsecured loan, is a loan from a bank or building society that is not secured against any assets, e.g. your home. It is typically a fixed amount of money borrowed over a fixed period of time at a fixed interest rate (although variable interest rate loan products are also available).

How do personal loans work?

A set amount of money will be available for you to borrow when you take out your personal loan. Your loan provider will also set the term over which you need to repay your loan and the interest rate that will be charged on the amount you have borrowed. Then you will make fixed monthly repayments to pay down the balance you owe on your loan.

For example, if you were to take out a £7,500 loan over a three-year term at an interest rate of 2.8%, your payments would be £217.33 per month and you would pay £323.88 in interest over the term, meaning your total repayment would be £7,823.88.

Personal loan rates

One of the first things to look at when comparing personal loans is the headline interest rate, which shows how competitive the lender is.

The interest rate determines how much extra money you would repay on top of the value of the loan. It also lets you calculate your monthly repayments and therefore whether you would be able to afford the load.

Interest rates on personal loans typically vary depending on the amount you borrow. If you borrow a smaller amount, say £1,000 to £2,000, then interest rates are usually between 9% and 10%. However, if you borrow between £7,500 and £15,000, the interest rate usually drops to around 3%. Once you start looking to borrow over £25,000, rates start to climb.

Personal loan rates have been steadily declining in recent years, after an initial spike following the financial crisis. The Bank of England base rate has been at a record low (at the time of writing, it is 0.75%), which means the cost of borrowing has also been relatively low. However, the base rate could go far higher (the Monetary Policy Committee review it every six weeks), and any increases could be passed down by banks in their APRs. It’s best to make sure you understand the amount you will be required to repay and whether you can afford to.

Pros and cons of a personal loan

So, you are thinking of taking out a personal loan… What are the benefits or pitfalls of this type of borrowing?

Pros

Cons

Why your credit score matters

As no collateral is required, you typically need to have a good credit score in order to be eligible to take out a personal loan. Due to you having nothing secured against the value you are borrowing, e.g. your property or your car, a loan provider needs to know that you are a safe bet for repayment. The provider will not lend you money if it thinks you are not in a position to pay it back and meet the interest charges.

During a loan application, you will typically be asked to provide information relating to your income and employment, as well as details of your monthly outgoings, in order to assess whether you meet the affordability criteria. Providers will also check your credit report, which is a personal history of all the credit you have taken out in the past six years. This data is held by three credit reference agencies in the UK: Equifax, Experian and TransUnion (formerly Callcredit). Lenders use your credit report to check their own records and then decide whether to lend you money. There is no universal credit score, and it is the providers that make the decision to lend, not the agencies. While one lender may reject your application, another one may be more positive.

Will having a personal loan affect my credit score?

Taking on any level of debt is likely to have some sort of impact on your credit score. Credit rating agencies do look at how many active credit accounts you have when compiling your credit report. So yes, a personal loan would be taken into account as a level of debt to be repaid. However, if you are a responsible borrower and make your monthly payments and pay your loan off in the set time period, then this could help your credit score as it shows a lender that you are reliable.

Also be aware that if you are rejected for a personal loan, this could impact your credit score. Make sure you read the eligibility criteria for a loan before you apply, and where possible use a provider’s eligibility checker (which will conduct a ‘soft search’) to see whether you would be likely to be approved for the product.

Loans for people with poor credit histories

If you have a poor credit score but are still interested in taking out a personal loan, then a specialised bad credit loan could be a potential option.

There are three types of bad credit loans:

  1. Unsecured loan – although the options for these will be very limited if you have a poor credit history
  2. Guarantor loan – where someone acts as a guarantor and agrees to repay the loan on your behalf if you default
  3. Peer-to-peer loan – where you borrow from people rather than from a financial provider

Bad credit loans typically have higher interest rates and lower amounts, so make sure you shop around to get the best deal.

How much can I borrow?

Loan providers typically offer between £1,000 and £25,000, with interest rates varying based on the amount you take out. How much you can borrow will depend on whether your application is approved.

Be wary of taking on more debt than you need to: it is not in your best interests to borrow up to your absolute limit if you can’t afford to pay it back. Some providers and financial comparison sites offer free loan calculators that let you see what your monthly repayments would be based on the amount you would borrow and the length of the loan’s term. This will help you assess whether you can afford to repay a particular loan.

How to compare personal loans

Borrowers are almost spoilt for choice when it comes to picking a personal loan. Here are the key things to consider when comparing products:

Should I get a personal loan?

Whether you should take out a personal loan depends on your personal circumstances and what you need to borrow money for.

Circumstances when a personal loan isn’t the right fit:

A personal loan is a financial product for the middle ground. It offers a bigger loan than you would get on a credit card, but not too much. You’ll be tied to the loan for several years, but you will clear your debt by the end of the term if you make your repayments. It can also be used as a tool to consolidate debt. If you have debts spread across different forms of credit, you could use a loan to repay them and to fix your interest rate so you know what your monthly financial commitments are.

What to do before applying for a personal loan

First check your credit score. If you were to make a loan application and it be rejected because you have a fair or poor credit score, this could further impact your credit rating. You can check your credit score through free services offered by the credit rating agencies.

If you need to rebuild your credit rating, here are some steps you could take:

Secondly, make a budget and calculate how much money you can afford to pay off each month. This will determine how much you can borrow and over how long. Be sensible about how much debt you take on.

Thirdly, check the product’s eligibility criteria. If a personal loan requires you to have a minimum annual income of £10,000 and you don’t, you could negatively impact your credit score by applying and being rejected.

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