Loans


Everything you need to know about personal loans

If you are interested in learning more about personal loans, then we have everything you need to know. From how they work to what sort of rates to expect – and even whether or not they will impact your credit score. If used correctly a personal loan can be a welcome injection of cash for that new car you are after, or a sound way to consolidate your existing debt. But in order to make it work for you, you need to know all the ins and outs. So let us guide you through it.

What is a personal loan?

A personal loan is a loan provided by a bank, building society, credit union or private lender which is not secured against any of your personal assets, such as your home.

Also known as an unsecured loan, it is typically a fixed amount of money borrowed over a fixed period of time with a fixed interest rate (although variable rate interest rate loans are available).

How do personal loans work?

Typically when you apply for a personal loan you will agree with your lender the amount you will borrow, the term over which you need to repay the loan and the interest you will be charged for the duration of the loan. You will then be required to make fixed monthly payments to pay down the balance of the loan.

So for example, you could borrow £12,500 at a rate of 2.9% for a term of three years. This means that you would be required to make monthly payments of £362.76 until you have repaid the loan in full. Therefore, the total amount you will have repaid over the three-year term would be £13,059.36, of which £559.36 will have been interest.

One thing to note is that you are able to make overpayments on your loan for free. If your loan was taken out on or after 1st February 2011, you can make partial overpayments on your loan without being charged — as long as they total under £8,000 in year. If they are above £8,000 in a year, then your provider is allowed to charge you if it has incurred a cost from you paying back the loan early.

Similarly, while you are allowed to pay back your loan in full, you may be charged an early repayment charge of around one to two months’ interest. How much depends on your individual provider.

What is a good rate for a personal loan?

When it comes to personal loan interest rates what you typically find is that the more you borrow, the lower your interest rate will be. Don’t be tempted to borrow more than you need just for this reason — that can lead to trouble. However, you should be aware of this aspect the market in case you are borrowing near a threshold of loan amounts. In that case, you may find borrowing just £100 more means you actually pay less in interest overall.

As mentioned, personal loan rates have different thresholds. So you may find that if you are borrowing under £5,000, you will be looking at a rate between 8.2% and 13.5%, while if you are borrowing between £5,000 and £25,000 it will be more like 2.8% to 3.6%. If you are looking to borrow an amount over £25,000, rates tend to vary much more, and many providers save their cheaper rates for existing customers.

When looking at personal loan rates it is important to know what is meant by APR (annual percentage rate). The APR is what you will owe on top of what you borrow. It is the advertised rate for the product, which means that it is offered to at least 51% of successful applicants. Therefore, it is not a guaranteed rate, and if you have a poor credit score you may find yourself being offered a higher APR.

What credit score do I need for a personal loan?

Lenders will look at your credit score as well as your income levels when deciding whether or not to approve your loan application.

As a general rule, you need a good credit score in order to be accepted for loans with decent terms. Lenders are looking for applicants who have a proven track record of paying credit back on time. That’s not to say you won’t be accepted for a loan if you have a poor credit score, but you may find that it is priced at a higher rate as you present a bigger risk to the lender.

Lenders also tend to look at your disposable income levels. When making your application you will most likely have to provide information about your income and outgoings. They will look at how much you have coming in and how much you have available to you once fixed costs such as mortgage payments and utility bills come out.

How does a loan affect my credit score?

Taking out a loan could have a negative impact on your credit score in the short term – but if you make your repayments on time and stick to the agreed terms, then this can be reversed in a matter of months.

The initial negative impact is largely the result of the application itself. An application for any form of credit can have an adverse effect on your score just because your lender will run a ‘hard’ search on your credit history. This leaves a footprint on your report, and lenders are not required to report to credit reference agencies whether or not the application was successful.

If you’ve applied for multiple loans this can also act as a red flag to lenders, as it could mean that you have been turned down for other loans or that you are trying to borrow more credit than you can afford. This is why it can be beneficial to thoroughly compare loan products, and maybe complete an eligibility checker before committing to a loan application.

It is also worth mentioning that your credit score is calculated by looking at how much debt you currently have, as well as many other factors. So if you are considering taking out a loan, just be mindful that this will show on your report as a form of debt and therefore may impact your ability to borrow more in the future.

Pros & Cons

If you are interested in a personal loan, what are the pros and cons of this type of product?

PROS

  • You can borrow more than on a credit card.
  • Interest rates are typically fixed, so you know how much your monthly repayments will be, making it easier to budget.
  • You decide the length of the term of the loan.
  • A lot of loans allow you to overpay without incurring penalties.
  • Personal loans are widely available from a range of providers, so you have a competitive selection from which to choose.
  • Personal loans are unsecured, so you don’t need collateral, such as a home, in order to take one out.

CONS

  • Interest rates tend to be higher than secured borrowing in order to offset the risk.
  • Personal loans typically require a good credit history, as there is no collateral.
  • Loans may carry early repayment charges — you would need to compensate your loan provider if you paid off the full amount before the end of your term. Check the details of the loan to see how much the charges would be.
  • Lenders typically have a minimum amount they will lend, so personal loans are not suitable if you only want to borrow a small sum.
  • Interest rates are lower the more money you borrow, which could tempt you into taking on more debt than you need to.
  • Monthly payments are fixed, so if your personal circumstances change there won’t be any scope to change how much you repay each month.

How to choose a personal loan

When it comes to personal loans, borrowers are often spoilt for choice. It is a competitive market with lots of options, so here are a few things you should keep in mind when choosing a personal loan.

Representative APR – This is one of the key elements of a personal loan, what rate of interest you are likely to be charged. As mentioned above, the APR is the advertised rate which 51% of successful applicants will get. You may end up with a higher rate depending on your personal circumstances. But looking at the APR is a good way to compare loan products, as the lower the APR the less you have to pay.

Monthly payments – Take a look at what your monthly payments will be. This will depend on the personal loan’s interest rate, how much you are borrowing and the term of the product. You can use loan calculators on comparison sites to change these elements and see which gives you a monthly payment amount that works for you. It is important to find a loan with a monthly repayment amount you can afford, as missed payments can have a disastrous effect on your credit score.

Early repayment charge – This is something to take into account if you feel you may be in a position to pay the loan off before the end of its term. Compare what you would be charged for an early repayment, or even look for a loan product which doesn’t have an early repayment charge.

Total amount repayable – Try to calculate the total amount you would have repaid by the end of the loan’s term. This will help you to understand the real cost of taking out the loan and make it easier to compare products.

Is a personal loan right for me?

Whether a personal loan is right for you depends on your own personal circumstances and what you are borrowing the money for. Loans can be a sound way to consolidate your debt and reduce your interest payments. Or they can be an affordable borrowing option if you are looking to buy a car, pay for a wedding or other big life expenses. They typically have a lower rate of interest than a credit card, and there are usually no fees attached.

However, there are some circumstances where a personal loan may not be the right fit.

  • If you are looking to borrow less than £1,000, then a credit card which has interest-free purchases could be a better option as you may struggle to find a loan for smaller amounts.
  • If you are unsure whether or not you can afford to make the same repayments each month, you may benefit from the flexibility that a 0% purchases, 0% balance transfer card or 0% money transfer card can give you.
  • If you are able to pay off the amount you are borrowing within several months, then a personal loan is probably not the right product for you. Personal loans typically have set repayment schedules that span several years, so an overdraft or credit card could be more suited to your needs.
  • If you are looking to borrow a large sum of money, then a secured loan could be a better option.

What to do before you apply for a personal loan

If you want to put yourself in the best situation for being accepted for a personal loan, there are a number of things you can do.

  1. Check your credit score. Having a good credit score makes it more likely you will be accepted for a loan. If you have a poor credit score, maybe takes some steps to help improve your score before committing to a loan application. You can check your credit score for free at each of the credit reference agencies.
  2. Make a budget. This will help you to calculate how much you can afford in repayments each month. It will also help you decide how much to borrow and over what time period. Be cautious about taking on too much debt, try to consider what you can really afford.
  3. Check the loan’s eligibility criteria. Some personal loans will require you to have a minimum annual income, and if you do not meet that requirement your application could potentially be rejected.
  4. Compare loan products. Try to shop around for the lowest interest rate available and look at other factors such as early repayment charges and the total amount repayable.

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