Personal loans How loans work

Housing

Your home is at risk if you miss a repayment on a secured loan

An unsecured personal loan can be a good way to borrow, particularly for larger amounts – as a general rule, loans tend to get cheaper the more you borrow, up to a maximum of about £25,000. An unsecured personal loan will usually be cheaper than a standard credit card and you can borrow more than with a current account overdraft. An advantage of personal loans is that you know you will be paying a fixed monthly amount over a fixed period of time.

Loan APRs

Loan companies should show the Annual Percentage Rate (APR) to be charged on loans in their adverts. This is the rate you should use to compare deals. The APR takes into account any fees and charges that you may have to pay, as well as the interest rate. The lower a loan's APR, the cheaper the loan.

Risk-based pricing

An increasing number of loan providers use your personal circumstances to determine the interest rate you will get. This means that the cheap rate you see advertised could well be different from the one you end up with. If you see a loan advertised with a 'representative rate', this almost certainly means the provider uses risk-based pricing to determine the rate you will get. At least half of borrowers must get the advertised typical loan rate, or a cheaper rate.

A problem with risk-based loans is that because you have to apply in order to find out the rate you will get, the provider will probably do a credit search and this will leave a 'footprint' on your credit history. If you have too many credit searches within a short period of time, this can adversely affect your credit rating. 

If you would rather know the loan rate you will be offered in advance, look for a loan which doesn't use risk-based pricing. It's also a good idea to check your credit file before applying for any form of credit, whether it's a personal loan or a credit card you want. 

Fixed rate, fixed term loans

Most unsecured personal loan providers will lend you a fixed amount of money at a fixed rate, to be paid back over a fixed period of time. This means that you'll always know how much you will have to pay each month, and for how long you will be paying it. 

Usually you can borrow between £1,000 and £10,000 using a personal loan, although loans for as much as £25,000 are sometimes available. Personal loans are generally paid back over between three and 10 years.

Because they have fixed monthly repayments, loans are sometimes the best option for people whose priority is budgeting. If you borrow using a personal loan, you will know from the first day you take it out when the loan is due to be repaid and the total amount of interest you will be charged.

Early repayment penalties on loans

If you want to pay more off your loan each month than is required, or want to pay it off entirely with a lump sum before the end of the term, some lenders might charge you a penalty for the privilege. It isn't unusual to be charged one or two months' interest. 

However, there are loan providers who don't charge early repayment penalties. If you think you might be able to pay off your loan early, it makes sense to go for one of these.

Secured loans

These are loans which are backed by your property. They might be worth considering if you want to borrow a larger amount of money, as their rates tend to be a bit lower than for unsecured loans. However, secured loans also tend to have higher minimum advances and longer minimum terms than unsecured loans. It's important to remember that paying a lower loan rate over a longer period of time can be more expensive than taking out a higher rate loan over a shorter period. 

It is also crucial to be aware that your home will be at risk if you can't keep up repayments on a secure loan. Therefore, this kind of borrowing should be treated with caution.

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