What is a personal loan?

What can a personal loan be used for?

You can use a personal loan for a range of purposes, whether you want to pay for home improvements, or treat yourself to a new car or holiday. You can use a personal loan just to get through to the next payday or to cover an emergency purchase like a new washing machine.

Personal loans can also be used to consolidate existing debt into one manageable monthly repayment.

What types of personal loan are there?

There are several different types of personal loan on the market. These include:

Unsecured loans

Most personal loans are unsecured. You won’t need to use an asset, such as your home, as collateral (or security). UK Finance figures suggest there are regularly £30bn to £40bn of unsecured loans outstanding at any one time in the UK, so if you take out a personal loan, you won’t be alone.

Personal loans are priced based on your credit score. Borrowers with a poor credit score may pay many times more than someone with a good credit record.

The interest rate is fixed when you take out the loan, so you’ll know exactly how much your monthly repayments will cost you.

You’ll be able to select how long you want to repay the loan, provided it’s between one and seven years (some lenders only offer loan terms of between one and five years).

Secured loans

Secured loans require an asset as security when borrowing money.

Because this security lowers the risk for the lender, you are more likely to be offered a secured loan, loan amounts might be higher and interest rates can be more competitive compared with unsecured loans.

However, secured loans are higher risk for the borrower. If you are unable to keep up with your loan repayments, after a certain number of missed payments you will be considered to be in default.

The lender then has the right to repossess your asset and sell it to recoup its money.

The most common type of secured loan is a mortgage, which uses a home as security. Pawnbroking is a form of short-term secured borrowing.

According to accountancy firm Mazars, pawnbrokers lent a total of £223m in 2022. Pawnbrokers charge an interest rate, called the APR, of as much as 160%.

Short-term loans

Short-term loans are designed to let you borrow from £50 to £1,500 for between a few weeks and 12 months. They tend to charge higher rates than other types of loans but the UK regulator, the Financial Conduct Authority, capped what it calls high-cost short-term credit (HCSTC) so you never repay more than double the amount borrowed.

How much could I borrow?

You can typically borrow between £1,000 and £25,000 with an unsecured personal loan. Secured loans, if you have an expensive asset as collateral, let you borrow more than this. Pawnbrokers will lend small amounts depending on what you offer as security. Payday loans may be for just £50 or so.

Keep in mind that even if you’re offered a larger sum of money than you need, always think about whether you would realistically be able to afford to repay it. Go for a smaller sum if you think you might struggle to meet the repayments.

How much could a personal loan cost?

The cost of a personal loan will depend on the size of the loan, the length of the term, and the APR. Lenders will offer their lowest APRs to those with a good credit score.

You might be able to borrow anywhere between £1,000 and £25,000 with an unsecured loan. But the lowest interest rates are generally on sums of between £7,500 and £15,000.

The table below was compiled using an online loan calculator. It shows how much the monthly repayments might be for a £10,000 loan over different terms and at different interest rates. It demonstrates how the monthly repayments are reduced when the loan is taken out over a longer term. But the total amount repayable is greater.

£10,000 loan over two years

£10,000 loan over three years

£10,000 loan over five years

How do I find the best loan deals?

To find the best loan deals, follow the steps below:

• Shop around: The first step to finding the cheapest personal loan is to carry out a personal loan comparison. Compare a range of deals from several different lenders.
• Improve your credit score: The better your credit score, the more likely you are to be accepted for the best personal loan rates. Check your credit report for free with one of the three main credit reference agencies, Experian, Equifax and TransUnion, and correct any errors as soon as possible. Make sure you’re registered on the electoral roll, to show you have a permanent address, and always pay bills on time.
• Consider whether it’s cheaper to borrow more: In some cases, borrowing a larger sum could put you in a lower APR bracket. For example, if you want to borrow £7,000 over five years with a leading high-street bank, you might pay 7.3% APR. But if you were to borrow £7,500, the rate would drop to 6.2% APR. However, you need to weigh up whether you can realistically afford to repay that additional sum – only ever borrow what you can afford to pay back.
• Check the terms: Find out whether it’s possible to pay back your loan early without paying a fee and whether there are any fees for arranging the loan.

How do personal loans work?

If you’re accepted for a personal loan, a lump sum of cash will be transferred to your account, and you’ll then start making your repayments in regular instalments. But there are a number of factors you should consider when applying for a personal loan:

Interest rates

When comparing personal loans, be aware that you might not get the interest rate (APR) you see advertised. When a loan is advertised with a ‘representative APR’, it means that at least 51% of successful applicants will get this rate.

If you’re in the remaining 49%, you could be given a different rate, which could higher. The best APRs are reserved for those with good credit.

Eligibility criteria

Before you apply for a loan, it’s important to check you meet the eligibility criteria. You’ll typically need to be at least 18 years old and have a permanent UK address.

You might also need to meet minimum income requirements and some lenders will check that you don’t have a history of County Court Judgments (CCJs) or insolvency.

Many lenders now offer eligibility checkers. These let you find out how likely you are to be accepted for a particular loan as well as the interest rate you’ll be offered.

Eligibility checkers use a soft credit check, which means there will be no impact on your credit record. When you know which loans you’re likely to be accepted for, you can go ahead and apply in full.

Credit score impact

Applying for a personal loan in full will involve a hard credit check. This means the lender will check your credit report to see how well you have managed credit in the past and whether you have a history of missed payments.

A hard credit search will show up on your credit report and can cause a temporary dip in your credit score. That’s why it’s best not to make too many applications for credit in a short amount of time.

Repayment

Once you’ve been accepted for a personal loan, you’ll need to start making your monthly repayments. These tend to be fixed, so you’ll know exactly how much you need to budget for each month.

Choosing a longer repayment term will lower your monthly repayments. But it also means you’ll pay more in interest overall, making it more expensive. Always check that your monthly repayments will be affordable before agreeing to anything.

Can I get a loan with bad credit?

You can still get a loan with bad credit. However, you might have fewer lenders to choose from and personal loans for bad credit tend to charge higher APRs than for those with a good credit history.

For example, on a loan of £7,500, you might pay an APR of more than 25%, whereas someone with a good credit score might be paying a single figure APR. You might also find that you can’t borrow as much as you would like.

Pros and cons of a personal loan

What happens if I can’t pay my loan back?

If you can’t pay back your loan and miss loan repayments, you could be charged a fee and it will have a negative impact on your credit rating.

Defaulting on your loan can lead to serious consequences, such as the lender starting debt collection proceedings or taking court action against you.

If you’re struggling to meet your monthly loan repayments, contact your lender as soon as possible. Your lender should be understanding and work with you to help come up with a new repayment plan that will make your credit agreement more affordable.

In situations where you think your lender has provided you with an unaffordable loan, perhaps because it didn’t carry out the necessary affordability checks, you have the right to raise a complaint. The lender has eight weeks to respond.

If you remain unhappy, you can take your complaint to the Financial Ombudsman Service (FOS). But keep in mind that this can be a lengthy process.

The FOS will investigate your complaint and if it agrees, it will look to put things right. This might be through refunding you the interest and charges you’ve paid or removing any negative information on your credit file.

Personal loan alternatives

If you’re not sure whether a personal loan is the most suitable choice for you, take a look at the following alternatives:

• Credit cards: Some credit cards offer 0% introductory periods, where you won’t pay any interest on your purchases for several months. This can help spread the cost of an expensive purchase. But you’ll need to repay the balance before the 0% deal ends and interest kicks in.
• Overdrafts: It can be quick and easy to apply for an arranged overdraft on your current account if you don’t already have one. This can be a good option for borrowing funds over a short time, but interest rates can range up to 40%.
• Guarantor loans: This type of loan requires a friend or family member with a better credit rating than you to act as a guarantor and repay the loan if you’re unable to. This reduces the risk for the lender and means it is easier to be accepted. However, your guarantor often needs to have an excellent credit rating and be a homeowner.
• Car finance: If you’re buying a car, you could use car finance to help spread the cost. Some dealerships offer 0% finance deals, but you can also choose from a range of other options including hire purchase and personal contract purchase. Or you can lease.

How do I manage a personal loan responsibly?

To manage a personal loan responsibly, keep the following in mind:

Repayment strategies

When taking out a personal loan it is vital you have a repayment strategy in place.

Make sure you have enough money in your account on the day you need to make your loan repayments. If you get a choice about which day your repayments go out, make sure it comes after your salary or other income arrives in your account.

Use a personal loan calculator (many lenders have them on their website) to help you work out what your monthly repayments will be. Then take a look at your bank statements, working out how much money you have coming in each month and how much you spend on bills and other expenses and at what time of the month those costs go out.

Dealing with financial difficulties

As soon as you have any concerns about meeting your monthly repayments, get in touch with your lender. It’s much easier to sort out the risk of a loan default early on, and your lender might agree to freeze payments for a while, or reduce your interest rate.

You could also look for advice and support on the Money Helper website, as well as speak to a free debt advice charity. These include Citizens Advice, StepChange and National Debtline. They can take a closer look at your finances and personal circumstances, and help you come up with a solution.

Summary

A personal loan can be a useful way to borrow the cash you need. But it’s important to research your options carefully. Keep in mind that you’ll need a good credit score to get the very best interest rates, and it’s important to only ever borrow an amount you are confident you can pay back. If you do have trouble meeting your monthly repayments, speak to your lender straight away.

All lenders should be approved by the Financial Conduct Authority (FCA). You can check a lender is on the Financial Services Register on the FCA website. That way you know the company is legitimate.