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Personal loans explained

Find out how much you can borrow with a personal loan and what the difference is between a secured and unsecured loan. 

In this article
What is a personal loan? Personal loans: how much do they cost? What loan rate will I get? How long can I borrow money for?
What are early repayment penalties? What is a secured loan? Alternatives to personal loans

What is a personal loan?

If you're looking to borrow a lump sum over a fixed period of time, an unsecured personal loan could be for you. 

An unsecured personal loan will usually be cheaper than a standard credit card, and you can borrow more than with a current account overdraft.

But you need to know how these loans work, what to watch out for and how they compare with secured loans.

 

Personal loans: how much do they cost?

Personal loans are a particularly good way to borrow if you need a larger amount – as a general rule, loans tend to get cheaper the more you borrow, up to a maximum of about £25,000. 

Loan companies must show the annual percentage rate (APR) charged on loans in their adverts.

The APR takes into account any fees and charges that you may have to pay, as well as the interest rate. This is the rate you should use to compare deals – the lower the APR, the cheaper the loan.

Go further: see our round-up of the cheapest personal loans on the market to help you find the best deal

What loan rate will I get?

Bear in mind that all advertised loan APRs are 'representative', meaning that not all successful applicants will be offered that rate.

At least 51% of borrowers must get the advertised typical loan rate, but you could end up with one that’s higher.

The problem with this risk-based pricing is that because you have to apply in order to find out the rate you’ll get, the provider will run a credit search and leave a ‘footprint’ on your file.

Too many credit searches within a short period of time can adversely affect your credit rating.

What is APR?

In this two-minute video, Which? explains what APR stands for and how it's different from a standard interest rate. 

The video also explains why some credit card customers are offered a higher or lower APR than others.

 

Go further: check your credit report before applying for any form of credit to get a better idea of how likely you are to be accepted

How long can I borrow money for?

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 know from the day you take it out how much you’ll have to pay each month, when the loan is due to be repaid and the total amount of interest you'll be charged.

Usually, you can borrow between £1,000 and £10,000 with a personal loan, although loans for as much as £25,000 are sometimes available.

Personal loans are generally paid back over a period of between three and 10 years.

Go further: peer-to-peer lending explained – find out about an alternative way to borrow

What are early repayment penalties?

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.

Go further: how to cancel a loan – we explain what to look out for if you want to cancel a loan early.

What is a secured loan?

Secured loans are backed by your property, meaning that your home could be repossessed if you're unable to keep up with repayments.

For this reason, it's wise to tread very carefully when considering this type of borrowing.

Secured loans might be worth considering if you want to borrow a larger amount, as their rates tend to be slightly lower than unsecured loans.

However, secured loans also tend to have higher minimum advances and longer minimum terms. 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. 

Secured loans have variable rates, meaning that your provider can increase the cost of borrowing at any time.

However, because unsecured loans are at a fixed rate, you know from the outset how much you'll be paying. 

An alternative may be to increase your mortgage. Find out more in our guide to remortgaging to release equity and cash from your home.

Alternatives to personal loans

 

Credit cards

 

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.

Credit cards offer valuable protection under Section 75 of the Consumer Credit Act and chargeback rules.

 

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 less 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.

 

Remortgaging

 

Remortgaging is when you take out an additional or different mortgage against your property.

Typically you might consider remortgaging to save money on your repayments with a cheaper deal, but it's also an option to help you release some of the equity tied up in your property or to borrow a bit more money.

Remortgaging is pretty straightforward but it's worth speaking to a mortgage adviser who can help you work out if it's the right option for you.

 

Hire purchase

 

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

 

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.

 

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