Personal loans: what you need to know
Your loan options
Article 2 of 3
Your loan options
Take a look at the borrowing options available to you to make the best decision for your needs.
As a prospective borrower you'll be faced with a wide range of options, but it's important to understand what they entail and how much they're likely to cost before deciding which one to choose.
To make this decision easier, we've rounded up a variety of ways to borrow, outlining how each one works and when they might be worth considering.
Credit cards work on a system called 'revolving credit', which means that you have a credit limit – £1,000, for example, and you can choose to borrow anything up to £1,000 on the card at any one time. Once you've reached your credit limit, you can't spend any more on the card until you've paid some of it off.
Unsecured personal loans
Personal loans are a good way to borrow for larger items over a fixed period. If you've got existing debt (for example on credit cards with a high APR), personal loans can be a handy way to consolidate borrowings. The interest rate (APR) is set when you take out the loan and the repayments stay the same every month for the term of the loan.
Interest rates on personal loans tend to be lower than those on credit cards, except for borrowing smaller amounts. As a general rule, loans tend to get cheaper the more you borrow, up to a maximum of about £25,000.
Credit union loans
Loans from credit unions are generally cheaper than loans from most other providers for smaller amounts and do not incur set-up fees, administration costs or early redemption fees.
Many credit union loans will cost 1% a month on the reducing balance of a loan (an APR of 12.7%). Some credit unions may charge more than this, although by law the amount of interest charged by a credit union can be no more than 2% a month on the reducing balance of a loan (an APR of 26.8%).
Peer-to-peer lending websites
Peer-to-peer lending sites match savers who are willing to lend with borrowers - either individuals or small businesses. Rates can be better than those offered by banks - as high as about 16% for savers, and as low as about 5% for borrowers on a five-year loan. But they also come with greater risk and lower protection.
Bank account overdrafts
An authorised overdraft on your current account can be an excellent short-term way to borrow. Some banks even offer an interest-free overdraft.
Hire purchase is a form of finance usually arranged through the retailer selling you goods. It is commonly used for car finance.
Under a hire purchase agreement for a car, you usually pay an initial deposit, normally at least 10% of the car's price. Then you pay the remainder, with interest, in monthly instalments.
Payday loans are designed to offer short-term loans to tide you over until you receive your monthly salary. They are never suitable for medium or long-term borrowing.
They promise a quick decision with no credit check, but APRs on payday loans can be incredibly high. Bank overdrafts, credit cards and credit unions will usually offer better value.
Borrowing from a pawnbroker
Pawnbrokers lend you money in return for an item you provide, or ‘pledge’, as security – typically jewellery. As the loan is secured on an item of value, which the pawnbroker can sell if you default on the loan, your credit history is not checked before you can borrow.
The term of the loan is usually six months, although it can be longer. You can pay the loan back whenever you want and get the item back. You pay interest for each month you borrow the money.
- Last updated: July 2016
- Updated by: Rob Goodman