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How do personal loans work?
Personal loans, or unsecured loans as they are also known, enable you to borrow a lump sum of money over a set term. You then pay back the amount borrowed in fixed monthly instalments, with interest added on top. Interest rates for personal loans are usually fixed but the rate you pay will depend on factors such as the amount you borrow, the length of the term and your credit history.
Interest rates tend to be the most competitive for loan amounts of £7,500 or more. You can usually borrow between £1,000 and £25,000 with a personal loan, over a term of between one and five years – although some lenders will allow you to borrow for up to seven years.
What are the advantages of personal loans?
- Personal loans do not require you to use an asset, such as your home, as collateral
- Monthly payments are usually fixed, making it easier to budget
- Once your loan is approved, the funds will usually be in your account within a few hours
- You can choose how long you want your loan term to be – typically up to five years but this can be longer
What are the disadvantages of personal loans?
- Interest rates can be higher than for secured loans, particularly for smaller loan amounts
- If you are unable to repay your loan, you risk damaging your credit score
- You will need a good credit rating to secure the most competitive interest rates
- A fee may apply if you pay back your loan early, but not always
What can I use a personal loan for?
You might take out a personal loan to fund a wedding, pay for a new car, fund a trip of a lifetime, or cover the cost of expensive home improvements. Personal loans can also be used to consolidate existing debts (such as other loans or credit cards) into one manageable monthly repayment.
How much can I borrow?
This will depend on your financial circumstances and your credit rating. Most lenders will allow you to borrow between £1,000 and £15,000, but some offer larger loan amounts of up to £25,000.
Do I need a good credit score to get a personal loan?
If your credit score is in good shape, you’re more likely to get accepted for a loan and you’ll have access to more favourable interest rates. If your credit score is poor, your loan application could be rejected or, if not, you may be offered a higher rate of interest.
The good news, however, is that some lenders offer guarantor loans, whereby a family member or friend guarantees they will pay off your loan if you can’t, or bad credit loans which are designed for those with a low credit score.
Our expert says
Personal loans offer a flexible and easy way to borrow funds. However, you’ll need a good credit rating to secure the most competitive interest rates and it’s always best to repay your loan as quickly as possible. If you are struggling to keep up with your repayments, speak to your lender straight away.
Rachel Wait - Personal Finance Journalist
FAQs
What’s the difference between an unsecured and secured loan?
Unsecured loans are not linked to an asset which makes them less risky for the borrower but also means interest rates can be higher. Secured loans, on the other hand, are linked to an asset, and this is usually your home. This means if you are unable to repay your loan, you may be forced to sell your home so the lender gets its money back.
What does APR mean?
The APR stands for annual percentage rate and is used to show the overall cost of borrowing for a year. It’s used to compare both loans and credit cards and includes the interest on your loan as well as any fees or charges.
If the APR is representative, this means it only has to be offered to 51% of successful applicants, while the remaining 49% could be offered a higher APR. If the APR is guaranteed however, this means you will receive the loan at the rate shown if you take it out.
What happens if I miss a repayment?
If you miss a repayment, you may be charged around £25 and your lender will ask you to make up the missed payment as soon as possible. You may also find the rate of interest you’re charged increases.
What if I can’t repay my loan?
If you are unable to repay your loan, the consequences can be more serious so it’s important to contact your lender immediately and explain the situation. Your lender may be able to come up with an alternative repayment plan to help you get back on track. Alternatively, you could speak to a free debt advice service.
Continuing to miss repayments on your loan could have a negative impact on your credit score and affect your chances of getting credit in the future, so always seek help as soon as possible.
Can I cancel my personal loan?
When you apply for a loan, you’ll have 14 days from either the date the loan agreement was signed or when you received a copy of the agreement, whichever is later, to cancel the loan. This is known as the ‘cooling-off period’.
If the loan funds have already been transferred to your account, these must be paid back within 30 days.
Can I pay off my loan early?
Usually, yes but you may have to pay an early repayment charge. This is often the equivalent of one to two months’ interest.
Is it better to get a loan or a credit card?
This will depend on how much you need to borrow. For those looking to borrow smaller sums of around £1,000 to £2,000, an interest-free credit card will be a cheaper option but only if you clear your balance before the interest-free deal ends.
If you need to borrow several thousand pounds, a personal loan is likely to be a better choice as most credit card credit limits won’t stretch this far.
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