What is a loan?
Loans allow you to borrow money to use for anything you need, from a new car to paying off existing debt.
Key takeaways
Loans can be used for just about anything, from home improvements to wedding expenses
When a loan is confirmed, the borrower agrees to pay the money back over a set time period, with interest
You can boost your chances of getting a loan by registering on the electoral roll, and paying your bills on time
What is a loan?
A loan is an agreement where a borrower receives money from a lender. It is then paid back over a set period along with interest. Loans come with the responsibility of making payments on time. If payments are late, or not made, there can be serious financial consequences.
How do loans work?
1. Find a loan
There are lots of different providers offering loans, and several different types of loan. Never take the first loan you see and always compare the loans on offer.
2. Apply for a loan
The loan process begins with an application, which can be online, via an app, or sometimes in a bank branch. You will need to give your personal and financial details.
3. Credit check
Lenders perform a credit check to evaluate your creditworthiness. This assessment helps determine whether you're eligible for a loan and what interest rates you'll be offered. This is a hard credit check and it will be visible to other lenders.
4. Lender's offer
Based on your credit score and personal circumstances, the lender will propose an interest rate and loan amount. It's essential to review this offer carefully to ensure it aligns with your financial situation.
5. Loan is paid to you, and repayments begin
If you accept the lender’s offer, it will transfer the loan to your bank account. You will then start to make repayments straight away.
Types of loans
There are a range of loans available, each designed to suit different financial situations:
Unsecured loans: Also known as personal loans, these do not require collateral and are paid back in monthly installments.
Secured loans: Require collateral, typically your home, and come with the risk of seizure upon default.
Guarantor loans: Involve a third party who agrees to cover the loan if you default, often used by those with bad credit.
Bad credit loans: Bad credit loans cater to individuals with a low credit rating.
Emergency loans: Designed for urgent needs but come with high-interest rates.
What can you use a loan for?
Loans can finance a variety of expenses:
Car loans: For purchasing vehicles, with various financing options available.
Debt consolidation loans: To pay off other debts and simplify repayments.
Home improvement loans: For funding renovations, available as secured or unsecured.
Wedding loans: Unsecured loans to cover wedding expenses.
How much can you borrow?
The amount you can borrow varies based on factors like your credit score and income. A good credit score can lead to higher borrowing limits, while a poor score may restrict your options. It also depends on the type of loan you’re taking out. Typically you can take out more with a secured loan than an unsecured loan.
When are loans repaid?
Loans are usually repaid monthly, with penalties for missed payments. Some lenders will also charge you a penalty if you want to repay your loan early.
How to apply for a loan
You can apply for a loan through various channels, including directly to the lender, online or via an app, or in person at a bank branch.
How to boost your chances of getting a loan
Banks will look at your credit score when assessing how much to lend you, and what interest rate to charge.
To improve your credit score, consider steps like registering on the electoral roll, disconnecting from financial associates with poor credit, and always paying bills on time.
The pros and cons of loans
There are lots of things to weigh up when it comes to taking out a loan.
The pros:
Handy way to access finance if you don’t have the money in your bank
Interest is often cheaper on loans than other forms of finance
One option for consolidating debts – making repayments simpler with one payment
The cons:
Another form of debt which if you don’t repay can harm your credit score and cost you more money
The best rates are reserved for those with good credit scores
There may be charges for repaying early
What is the difference between a loan and a credit card?
Loans and credit cards both allow you to borrow money but they work in different ways. Loans tend to be used for larger purchases, such as a new car, while credit cards are for items such as a fridge or holiday expenses. Here are a few key differences:
Loan | Credit card | |
Borrowing limits | Can usually borrow more, up to £25,000 in some cases | For smaller amounts, usually below £10,000 |
Interest cost | Fixed interest from the start | Interest only on your balance |
Extra charges | May be charged for repaying early or late payments | Late or missed payments |
Payment schedule | Fixed for the length of the loan | Flexible, depending on how much you borrow |
What is the difference between a hard and soft credit check?
When you make an application for a loan, or any form of credit, a hard credit check will be made on your credit score. This will remain on your credit score and other lenders will be able to see it. This can have a negative impact, especially if you make lots of applications in a short amount of time.
If a soft credit check is carried out, this does not leave a mark on your credit score. There are lots of free tools you can use where you can check your eligibility before you apply for a loan. These use soft checks which aren’t permanent, but they show you how likely it is that you will be accepted for a loan.
What is the APR?
Loans accrue interest, which is the cost of borrowing money. The APR, or Annual Percentage Rate, indicates the yearly cost of a loan, encompassing both the interest rate and any additional fees. For instance, borrowing £5,000 over three years at an APR of 4% would mean monthly repayments of £147.46, with the total amount repayable being £5,308.56.
Alternatives to loans
Loans aren’t the only option, and they won’t suit everyone. Here are some of the alternatives:
Overdrafts
Credit cards
Credit union loan
Using savings
Useful guides
MoneySuperMarket is a credit broker – this means we’ll show you products offered by lenders. We never take a fee from customers for this broking service. Instead, we are usually paid a fee by the lenders – though the size of that payment doesn’t affect how we show products to customers.
Author
Rebecca Goodman
Personal Finance & Insurance Expert
Rebecca is an award-winning financial journalist with over a decade of experience writing for print and online media. Her mission is to take the jargon out of personal finance and to help everyone...
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Collette Shackleton
Content Writer
Collette Shackleton is a highly skilled Content Writer who has over nine years’ experience creating helpful and engaging personal finance content for consumers. Collette shares her experience as a...
