What is a personal loan?

What is a personal loan?

author: Bryony Pearce

By Bryony Pearce

Financial jargon can get super confusing at times, so we’re clearing up what a personal loan actually is.


So you’re looking to borrow some money and you’ve been bombarded with options: personal loan, unsecured loan, homeowner loan, secured loan, payday loan, guarantor loan…

There’s so much loan jargon out there it’s easy to feel overwhelmed and confused. We’re here to bust the jargon and clear up any questions you have about personal loans, so let’s take a closer look at what they are.

All there is to know about personal loans

A personal loan – also known as an unsecured loan – isn’t secured against anything you own such as your home. So you don’t need to worry about your house being repossessed if you can’t keep up with the payments. Phew!

This is a different loan compared to overdrafts and credit cards as it allows you to borrow a fixed amount, over a fixed term and usually on a fixed interest rate. All of these details are agreed upon between you and the lender. However, the amount you can borrow will depend upon your circumstances and credit history. If you’ve struggled with credit repayments in the past, your bad credit score will mean a lender may charge you a higher rate of interest.

Also, it’s good to know some lenders may charge arrangement fees (which cover the costs of administration) and this could bump up the cost of taking out credit. Additionally, if you want to pay off the debt earlier than the agreed loan term, you could end up paying early repayment charges.

So to round up, if you’re looking to borrow under £25,000, you know how much you can afford to repay each month, and you have a good credit history, you may want to consider a personal loan.

For more information on personal loans and bad credit, take a look at our article on it here: ‘Can I get a loan with bad credit?’.

What other options are available?

There are many options available to you if you need to borrow money, and they’re not all loans. Credit cards and planned overdraft facilities are popular options and they may be able to offer the additional cash flow you need. Plus, with a credit card, if you pay off your balance in full each month, you won’t have to pay any interest. Result.

As with anything in life though, there are a few drawbacks. Credit cards don’t come with the security of a pre-agreed monthly payment amount, therefore things can quickly spiral out of control if you struggle with budgeting. Similarly, an overdraft requires no minimum monthly payment and, as a result, a large balance can soon feel impossible to clear.

Why choose a personal loan?

Unlike the two options above, with a personal loan, you make an agreement with your lender about how much you’ll borrow – and this is what you’ll pay back in monthly instalments, plus interest. This makes it a much simpler form of borrowing, and budgeting for the repayments is more straightforward as the amount stays the same every month.

A personal loan can also be a nifty way of consolidating existing debts into one easy monthly payment – but remember that if you extend the duration of the loan, the total amount might be higher due to interest.

loans

Are there different types of loans?

Of course! Other types of loans are available and they could be more suitable for your needs. These include:

Secured loans

A secured loan is a loan secured against an asset (usually your home). It’s important to note that with a secured loan, your home is used as security and could, therefore, be at risk if you’re unable to make the repayments.

While this means you can usually borrow more at a lower rate of interest than with a personal loan, because secured loans start at £10,000, your repayment term and total interest paid will likely be longer and higher.

Secured loans are sometimes referred to as a homeowner loan because homes are usually what the debt is secured against. While the lower interest rates and higher payouts may sound appealing, secured loans run the risk of repossession. So, if there’s any doubt in your ability to pay your monthly instalments, or any concern that your future circumstances could change, taking out further credit isn’t recommended.

Payday loans

Payday loans usually lend less than personal loans – normally up to £1,000 but some lenders even restrict the size of the first loan they offer. Along with the smaller loan amount comes shorter loan terms which can span from less than a week to several months.

You’ll be pleased to hear that there aren’t usually early repayment charges (but always check with your lender first). There are fees for setting up the loan, however, as well as a higher interest rate which is usually calculated on a daily basis. It’s important to never miss a payment as charges can quickly mount up – plus extra interest and fees can also be added.

So yes payday loans are a more expensive option than a personal loan and other types of borrowing… but even people with poor and adverse credit histories can be accepted.

Guarantor loans

A guarantor loan is another type of unsecured loan which involves another person formally agreeing to take over your repayments if you default or can’t keep up with them.

People with poor or no credit histories are more likely to require a guarantor which is often a family member or trusted friend with a good credit history. This makes the lender feel more comfortable with the loan arrangement as it is deemed less risky – allowing the applicant to borrow more money and at a lower interest rate than if they were applying for a personal loan themselves.

credit-history

Am I eligible for a personal loan?

Eligibility is based on your income and credit history. Your lender will assess both of these things and your circumstances in order to decide whether or not to approve your loan application. It may be turned down if there is a concern over your ability to afford the repayments over the term of the loan. You may also find it hard to get accepted if you have a bad credit score as this suggests that you’ve struggled to manage credit in the past. You may also be rejected if you don’t have a credit file or thin credit file.

Your credit history is a record of each type of credit you’ve opened in the last six years, along with details of your repayments. If you’ve missed payments in the past, lenders can see this and may turn down your application if they think you’re unable to borrow money responsibly. On the flip side, payments that are made in full and on time are seen as a big tick against your credit history, which will have a positive impact on your credit score.

If you’re considering applying for a personal loan, you first need to work out how much you can afford to pay towards it each month. You should only ever borrow what you can afford to repay so you don’t find yourself stretched each month.

If you don’t stay on top of your repayments you could be hit with charges or additional interest by your lender. As well as making your repayments more expensive, the missed payments will also show up on your credit history – affecting your credit score and making it more difficult for you to borrow in the future.

We hope we’ve answered a few of the questions you may have had about personal loans. Keep checking the blog as we bust more financial jargon!

Disclaimer: All information and links are correct at the time of publishing.

author: Bryony Pearce

By Bryony Pearce

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What is a personal loan? What is a personal loan?