Back to Basics: Everything you need to know about loans

A low-rate loan is a great way to spread the cost of a big outlay – for example a wedding, an extension or a new car.

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For anyone who owes money across several credit cards or accounts, a loan is also a useful debt consolidation tool that can both slash interest payments and make it easier to clear their debts.

Here, we explain everything you need to know about the various types of loan available, so that you can make the right choice for you.

What is a personal loan?

A personal loan is also known as an unsecured loan and is a way of borrowing money from a lender such as a bank or building society. You choose the amount you wish to borrow and the period of time you want to borrow it over within given parameters. The lender will then decide whether or not to accept you as a customer on those terms, based on your credit score.

Unsecured personal loans, with which you do not have to put up a property as security, are generally available for amounts of between £1,000 and £25,000 over terms of one to five years – though 10 years is sometimes possible. However, they are generally at their cheapest for between £7,500 and £15,000 over between three and five years. Either way, you make regular monthly repayments to pay back the full amount of capital plus interest at the agreed rate.

What is a secured loan?

With secured or homeowner loans, you have to use your property as security against the loan.  This means that they are only available to homeowners, and that if you default on your repayment you could lose your home.

You can borrow up to £100,000 with a secured loan and the maximum amount of time for repaying the loan is a lot longer at 25 years. Loans of this kind are therefore suitable for those looking to borrow larger amounts. As with personal loans, the repayment terms will generally involve fixed, monthly payments.

What other types of loan are there?

You may see loan providers talking about car loans or home improvement loans, but there are just unsecured, personal loans by another name.
The same is true of the loans offered by peer-to-peer lenders, the difference being that you borrow from other individuals keen to earn interest on their savings.

What factors affect the cost of a loan?

When choosing a loan, the first aspect to look at is the interest rate. The higher this is, the more you will pay back overall. And the bad news for people with low credit scores is that the lowest interest rates are generally reserved for borrowers with higher scores because they are seen as less of a risk by lenders.

Other factors to check include whether there are any fees, such as early repayment or arrangement fees that could affect the overall cost of the loan.
Finally, compare loan conditions before making your choice – some are more flexible than others and may even offer the option of a payment holiday of say two or three months at the start of the agreement.

Will I qualify for a loan?

As explained above, whether or not you qualify for a personal loan will depend on your credit score. If you have a low score, for example because you have defaulted on debts in the past or had a County Court Judgment (CCJ) recorded against you, it is therefore unlikely that you will be accepted by lenders offering top deals.

You can take steps to improve your situation by applying for a copy of your credit report to check all the information held is accurate. You should also stay on top of all your bills and debt repayments. Secured loans can be a good option for anyone whose low credit score makes it hard for them to get a low-rate personal loan – so long as they are a property owner. But remember your home will be at risk.

What is the representative Annual Percentage Rate (APR)?

The representative APR quoted in loan advertisements is the headline interest rate figure the lender uses for marketing purposes. This does not mean that everyone who is accepted as a customer will pay that rate, though.

Many lenders calculate the APR of a personal loan using a system called risk-based pricing, which means the rate you are offered depends on the strength of your credit profile. And under current European Union rules, lenders only have to offer this rate to 51% of the people they take on as borrowers. The remainder can be offered a higher rate, which they can then choose whether or not to accept.

What are early repayment penalties?

Early repayment penalties, or redemption fees, are generally charged when borrowers want to repay their loans before the agreed term to compensate the loan provider for the resulting loss of interest.

A typical penalty could be equivalent to one or two months’ interest, although the penalties charged will often fall towards the end of the loan agreement.
Those keen to avoid redemption fees should look for flexible loans that can be paid off early penalty-free.

What is Payment Protection Insurance (PPI)?

PPI is designed to pay your loan, mortgage or credit card repayments if you fall ill or lose your job. However, the terms and conditions of the cover tend to be very strict and riddled with exclusions. And in the past, lenders have come under fire for insisting that borrowers take out linked PPI policies alongside their loans.

Most providers no longer do this, but if you are offered a PPI policy, it is worth remembering that standalone cover should work out cheaper and will also protect all your debts, rather than just this loan.

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