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What is a loan

Everything you need to know about loans

published: 19 August 2022
Read time: 5 minutes

Loans are a way you can borrow money – usually from a bank or other financial organisations

There’s a lot to know about loans. From how they work, what they’re best for and what to watch out for. Our guide takes you through what you need to know about loans. 

What is a loan? 

A loan is when you are lent money, typically by a bank or other financial provider – known as the ‘lender’.  

When you take out a loan, you owe the lender money and are expected to pay it back in an agreed timeframe.  Loans are usually paid back in the form of monthly repayments and have interest added to them. 

How do loans work?  

These are the stages you’d typically encounter in the loans process: 

  1. Applying for a loan: To apply for a loan, you’ll need to give the lender some information about yourself. You’ll be expected to give the lender personal details such as your name, address history for the last three years, employment status and bank details.  

  2. Credit check: When you apply for a loan, the lender will carry out a credit check. They do this to find out how risky it would be to lend to you. Generally, the higher your credit score, the better your chances of getting the loan – and at a lower interest rate or APR If your credit score is low it may be more difficult to be accepted for a loan.  You could consider a bad credit loan specifically designed for those with bad credit. 

  3. Lender gives you an offer: If the lender decides to give you a loan, this might not be at the advertised APR rate. The interest rate you’ll be offered will be based on your personal circumstances and credit score. It’s up to you whether you accept or decline the offer. 

  4. Making the repayments: If you choose to accept the lender’s offer they will typically send you the loan direct to your bank account within a few days. You’ll be given a timescale to make the repayments e.g.2 years. Loan repayments are usually monthly. It is important to keep up with your loan repayments because failure to do so can damage your credit score. If you’ve taken out a secured loan your home could be at risk if you fail to meet your repayments. 

How do interest rates work with loans? 

When you borrow money from a lender, the money you’re lent will accrue interest, which will increase the overall amount you’ll pay back over the loan term.  

APR stands for Annual Percentage Rate and for a loan, this relates to how much the loan will cost you over one year. For example, if you borrowed £5,000 over three years at an annual interest rate of 4%, you would make monthly repayments of £147.46 and the total amount repayable would be £5,308.56. 

What are the different types of loans? 

There are a range of loans available to suit your financial situation and needs: 

  • Unsecured loans: Sometimes known as personal loans, these loans allow you to borrow without putting down a valuable asset as security. You need to make the monthly repayments until the debt is cleared 

  • Secured loans: When you take out a secured loan, you put down a valuable asset as security – typically your home. But if you fail to make the repayments on your secured loan, your home could be seized by the lender to cover the costs 

  • Guarantor loan: This is a loan when a guarantor agrees to pay your debt if you can’t. Guarantors are usually family members or friends. Guarantor loans are usually aimed at those with bad credit who would find it hard to get a loan on their own. Like most bad credit loans, these loans will come with higher interest rates 

  • Bad credit loans: Bad credit loans are designed for people who have a low credit rating and who might find it hard to borrow elsewhere 

  • Emergency loans: Also known as payday loans, these are loans designed when you need money urgently. However, they should be seen as last resort loans because they have very high interest rates and can become expensive 

 What can I use a loan for? 

You can use a loan for a variety of reasons: 

  • Car loans: This is a loan taken out to buy a vehicle. The car loan could also be car financing such as personal contract purchase, hire purchase or car leasing 

  • Debt consolidation loan:  A debt consolidation loan is taken out to pay off other more expensive debt you owe. For example, if you owe debts on credit cards and an emergency loan, a debt consolidation loan could be taken out to help pay them off and reduce your overall monthly repayments 

  • Home improvement loans: Home improvements can be costly but you can take out a loan to help spread the costs, making them more manageable. Home improvement loans typically come in two types: unsecured and secured loan 

  • Wedding loans: Your big day can have a big cost and a wedding loan can help pay for it. Wedding loans are unsecured personal loans which you pay back over time with interest 

How much can I borrow with a loan? 

How much you can borrow will depend on a range of factors, such as your credit score, income and what the loan is for. 

  • Your credit score: Having bad credit may limit how much you can borrow. A good credit score indicates to lenders that you are a reliable lender and you’ll be able to borrow more than someone who has bad credit  

  • What the loan is for: Short-term loans are usually for smaller amounts, such as £100 to £1000. However, short term loans such as payday loans carry the risk of being very expensive as they have high interest rates. Personal loans usually range from between £1,000 to £25,000.  

How do loan repayments work? 

Loans are paid on an agreed date and repayments are usually made monthly. You will face penalties for not keeping up with loan payments and, in some in cases, for making early repayments. 

Penalties for missing loan payments: You’ll usually be charged a flat fee of around £25 if you miss a loan repayment. Missing repayments can also damage your credit rating. 

Penalties for early loan repayments: Some lenders will charge you a penalty – typically extra interest – if you want to repay your loan early. Always read the small print before signing up for a loan so you know the terms and conditions. 

How do I apply for a loan? 

You can apply for a loan in a variety of ways  -  directly to the lender, online, on the phone or in branch. Be aware that applying for many loans in a short space of time can negatively affect your credit score. 

That’s why searching with MoneySuperMarket makes sense. You can compare loan deals without harming your credit score so you can see which loans you’re likely to be accepted for and apply with greater confidence. 

Should I take out a loan or get a credit card? 

Whether a credit card or loan suits your borrowing needs best will depend on a range of factors, including how long you want to borrow and how much: 

If you need a large sum of money: If you need a large amount of money then a loan might be the more appropriate route because the interest charges are likely to be lower than on a credit card.  

Day to day spending: Credit cards can be useful for managing daily spending. Some cards, such as cashback credit card offer rewards on spending, for example and some cards offer 0% interest borrowing for a time. Credit cards work best if you can clear your balance each month to avoid incurring any interest. 

What else do I need to know about loans? 

Here are some terms you might see come up when talking about loans: 

Borrower: When you have been approved for a loan and are given the money – you are a borrower. 

Credit score: Also known as a credit rating, your credit score is a number which indicates to lenders how much of a reliable borrower you will be.  

Default: When you default a loan is when you don’t pay back the loan on the agreed terms you’ve set with your lender. 

Fixed interest rate: When a loan has a fixed interest rate, the interest rate stays the same throughout the loan term. Meaning you’ll always pay the same amount. 

Hard credit check: A hard credit check will happen when you apply for a loan or credit. Hard credit checks show up on your credit report and may negatively impact your credit score. Hard credit checks are visible to lenders. 

Soft credit check: Soft credit checks happen when you check your own credit report. When a lender checks to see your eligibility for loans and credit this is a soft credit check. MoneySuperMarket carries out soft credit checks and this type of check won’t affect your credit score. 

Variable interest rate: A variable interest rate is when the interest rate of the loan varies during the duration of the loan term. Meaning your monthly repayments will be different amounts.

What are the alternatives to loans? 

Loans are not the only way to borrow, here are some other options: 

  • Overdraft: Most current accounts have an overdraft and it allows you to spend more than the money you have in your current account. Overdrafts can come with high interest rates and charges. You won’t be able to borrow as much with an overdraft as you would with a personal loan because they usually range from £80 to £3,000 in some cases 

  • Gifted deposits: This is when someone usually a loved one – gives you money for the down payment of a property 

Other useful guides 

We have a range of guides to help you learn more about loans: 

Loans for young people 

Guide to secured loans 

What happens if you pay off a loan early 

Compare loans with MoneySuperMarket 

Looking for a loan can feel like a guessing game – you might not know who’ll accept you and what deal you’ll get. Comparing loans with MoneySuperMarket is quick and easy and takes out the guesswork. We’ll tell you your chances of being accepted for different loan deals so you can apply with more confidence.  

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. 


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