Loans can be tricky to understand so before you consider borrowing it’s good to know exactly how they work. We’ve put together everything you need to know about loans to help you make the right choice.
Loans are a good way to spread the cost of a big expense such as home improvements, a wedding or a brand new car. It is an amount borrowed from a lender which the borrower must pay back, usually every month with interest. Unlike credit cards, you receive the entire loan amount at the beginning of the term and you can borrow a larger amount than with a credit card.
Types of Loans Explained
Personal loans sometimes called unsecured loans, are loans that are not secured against an asset and are offered at any bank or building society. You can choose the amount you wish to borrow and how long for. Typically you can borrow up to £25,000 with a maximum repayment period likely to be around 10 years.
Lenders will decide whether or not to accept you for this type of loan based on your personal credit score. If you’re looking to take out a personal loan and need help improving your credit score, read our guide here.
A secured loan is one that is backed by an asset, meaning you have to use your property or car as security against the repayments. The interest on these loans are typically lower than personal loans but it’s a riskier option as you could lose your home if you can’t keep up with repayments. For example Ocean Finance are offering loans of up to £250,000 for a maximum repayment period of 29 years.
Debt consolidation loans
If you’ve lots of debts across several credit cards or accounts, a debt consolidation loan allows you to move them all into one account or loan. The way it works is the loan pays off all your existing debts so you only owe money to one lender. This can make it easier to keep up with repayments by reducing them to a manageable level, as well as reducing the interest you pay.
Provided you pay off the full amount and have no other debts it can positively impact your credit rating, since it shows lenders you’re managing your finances responsibly. However, before applying for a debt consolidation loan always check your credit report.
Pros and Cons of Loans
Here are the pros and cons of taking out a loan that you may want to consider before you apply:
- The amount you can borrow is a lot higher than on a credit card and the rates are competitive
- You can decide how long you want to repay what you owe so you can spread the cost over a number of years
- You apply for the exact amount you need to borrow whereas with a credit card where you won’t know what credit limit you’ll be offered
- Managing your debt with a loan is usually a lot simpler; a fixed amount is taken from your account each month until you have paid back in full what you borrowed
- Rates can often be higher for smaller amounts borrowed
- If you pay off your debt early you could be charged an early redemption penalty
Look out for the APR
Don’t bank on the APR advertised to be exactly what you’ll be offered. The APR (Annual Percentage Rate) is an interest rate that lenders quote to give you an indication of the cost of borrowing. Lenders use risk-based pricing, which means you’ll be offered an interest rate depending on your financial situation and individual credit file. Providers are also only required to offer the advertised APR to at least 51% of customers, so you may be offered a rate higher than the one stated.
Applying for a loan
Lenders will need to assess the likelihood of you being able to repay the loan and this is dependent on your credit score, among other things. If you have a history of CCJs (County court Judgements) or defaults, which have resulted in a low credit score, then it is unlikely lenders will accept you for the top deals.
Therefore, before you apply it is good to check your credit report and score for inaccuracies and take steps to improve your score should you need to. Find out more on how to achieve a better credit score with our guide here.
Once you have done this you could use our loans matcher tool to help you find the loans you’re most likely to be accepted for. This won’t affect your credit score and reduces the risk of being turned down
There is no guarantee that you will be accepted for a loan. However, knowing everything about them before you apply and shopping around for the best deals for your situation can help you make the right choice and improve your chances of getting the green light from a lender.