The Motley Fool
My Wallet Hero

What is a personal loan?

Personal loans can come in handy in all sorts of scenarios. Whether you are using it to buy a car or pay for some home improvements, a loan can be a well-needed injection of money.

But what exactly is a personal loan? And how does it work?

What is a personal loan?

A personal loan may also be referred to as an unsecured loan. Basically, it is a loan from a provider such as a bank or building society which is not secured against an asset such as your home.

Typically, you borrow a fixed amount of money over an agreed time period. The loan has a prearranged repayment structure and there is a fixed interest rate.

For example, you could borrow £12,500 at 2.9% for three years. This means you would be required to make monthly payments of £362.76 for the duration of the loan period. Taking interest into account, the total amount you would repay at the end of your three-year term would be £13,059.36.

Why get a personal loan?

A personal loan can be used for a variety of reasons, which we will cover in a moment.

You may be asking yourself why not reach for your credit card instead? Here are some reasons why, in certain situations, getting a personal loan may be the better option.

You can borrow more than on a credit card. The amount you can borrow with a personal loan is typically higher than you could borrow with a credit card. If you are looking to do some home improvements or foot the bill for a wedding, then you are probably looking at a larger sum of money than the average credit card limit reaches.

Interest rates are fixed. You know what interest you will be paying for the term of the loan, and therefore what your monthly payments will be. Some people struggle with credit card borrowing because it can be so flexible, which in turn can lead to balances sitting on the card unpaid. There is no such risk with a personal loan. You have a set monthly payment that you are required to make; this will not fluctuate during the period of the loan, because your interest rate is fixed. It is worth noting, however, that if you miss a loan repayment, you run the risk of damaging your credit score.

Loans are unsecured. This means that you don’t need to provide any sort of collateral in order to take out a personal loan. Therefore, you don’t have to be a homeowner in order to qualify for a personal loan.

Are there any downsides to a personal loan?

While there are several advantages to a personal loan, there are also some downsides:

  • Most personal loans require you to have a good credit score in order to be accepted.
  • Lenders typically have a minimum amount they will lend, so personal loans aren’t suitable if you are only looking to borrow a small sum.
  • Personal loans typically carry an early repayment charge: if you were to try to pay off the full amount of the loan before the end of the term, you would be charged a fee for ending your arrangement early.

What is a personal loan used for?

A personal loan can be used for a variety of reasons. However, as discussed, you can typically borrow a larger sum with a personal loan than with a credit card. Things that you may consider using a personal loan for include home improvements, buying a car, a wedding, a holiday or clearing your debts.

In relation to the last point, personal loan rates have been relatively low for a couple of years; in fact, loan rates are currently significantly lower than the average credit card APR. So if you have found yourself with large amounts of credit card debt that are being charged at a higher rate of interest, you could consider taking out a personal loan to pay off that debt and reduce your cost of borrowing.

Educating yourself on personal finance and understanding the financial products that you use everyday can make the difference between comfortable finances and constant stress. At MyWalletHero, we aim to make learning about personal finance rewarding and fun.

MyWalletHero, Fool and The Motley Fool are all trading names of The Motley Fool Ltd. The Motley Fool Ltd is an appointed representative of Richdale Brokers & Financial Services Ltd who are authorised and regulated by the FCA, and we are permitted in this capacity to act as a credit-broker, not a lender, for consumer credit products (our FRN is 422737). The Motley Fool Ltd does not have permissions for, and does not advise on, investment products and services, but may provide information on investment products and services.

The Motley Fool receives compensation from some advertisers who provide products and services that may be covered by our editorial team. It’s one way we make money. But know that our editorial integrity and transparency matters most and our ratings aren’t influenced by compensation. The statements above are The Motley Fool’s alone and have not been provided or endorsed by bank advertisers. The Motley Fool has recommended shares in Lloyds, Tesco and Barclays.