The UK loan market is a vast and for many people, often confusing.
The dictionary defines a loan as ‘a sum of money that is borrowed, and usually paid back with interest’. This is a very broad definition. The UK loan market features a wide selection of financial products that are available to consumers.
The Difference Between Secured and Unsecured Loans
Understanding the difference between a secured loan and an unsecured loan is very important for borrowers.
A secured loan is backed by something you own (usually your property).
If you cannot repay your debt, you are in danger of losing the asset that your loan is backed by.
E.g. Your property could be repossessed to cover the value of the debt.
Logbook loans are loans that are secured against your car. If you are unable to repay your debt, your car can be repossessed.
Mortgages and hire purchase agreements also come under this category.
Because the loans are backed by an asset, it can reduce some of the risk for lenders and as such, often come with relatively low-interest rates.
An unsecured loan is not backed by any of your personal property – such as your house or car.
Despite this, your belongings may be at risk if you default on your loan. A collections agency may make efforts to collect the debt if you avoid repaying what you owe, and may send bailiffs to your home.
Interest rates on unsecured loans are typically higher.
UK Loan Market: Types of Loans Available
The UK loan market is huge.
As well as personal loans (which are the first type of loan people often think of), there are other financial products that are classed as loans.
Mortgages are loans that are specifically associated with the purchase of property.
You can borrow the money up-front to pay for a house (or other types of property) and then incrementally pay back what you have borrowed.
With a fixed rate mortgage, you pay the same amount of interest throughout the life of an agreed period (often 3 – 5 years)
With an adjustable rate mortgage, the interest rate shifts according to wider financial markets.
Before taking out a mortgage, you should carefully research which type is right for you. Mortgage advisors can give you valuable professional advice.
In London alone, mortgage debt totalled £182 billion at the start of 2016. Owner occupied mortgage debt totalled £971 billion across the UK.
Second Charge Loan
A second charge loan, or second charge mortgage, allows you to borrow against the value of your home.They are the same as ordinary mortgages but are for people with an existing outstanding mortgage. If you wish to borrow a large amount of money and have built up equity in your property, then you can secure a large loan against your home.
A second charge mortgage sits below your regular mortgage. Money is usually borrowed over a term of between 3 and 25 years. If you miss repayments, the lender can force the sale of your home and repay your regular mortgage, retaining the rest of the funds to cover your debt with them.
Personal loans are provided by a bank or loan company. The money is provided as a lump sum and will usually offer much more competitive interest rates than other products (such as credit cards or store cards)
The borrower will usually receive the money directly into their bank account and spend on the things that they need.
Personal loans are unsecured debts, usually with fixed terms.
You can choose how much you would like to borrow and the term that you would like to spread repayments over. The amount of interest that you pay will usually vary based on these decisions and on your credit rating.
Loans are typically available for up to £10,000, paid back over three to five years (though repayment terms may be significantly shorter or longer).
Credit Union and Peer-to-Peer Loan
Many people thinking about the UK loan market do not consider P2P lending. With this type of loan, a borrower receives money from other individuals rather than a banking corporation.
Credit unions are self-help cooperatives, where members pool their savings to offer loans and credit to one another at lower rates than traditional lenders. Each credit union will have its own membership requirements, usually based on job or location.
Peer to peer lending is similar to credit union lending, but without money being pooled and without membership restrictions. Instead, individuals can lend cash to borrowers that they are matched with.
Lenders can use peer to peer loans as a form of investment, receiving interest on top of loan repayments, but will be putting their money at risk.
A payday loan is a form of short-term, high-interest borrowing. Payday loans are designed to cover brief financial shortfalls.
Borrowers typically pay the money back when they are next paid by their employer, or may instead have a short term instalment loan over 2-12 months.
Interest rates for payday loans UK are higher than with long-term loans, but the repayment period is much shorter.
Payday loans are not secured and are usually for amounts between £100 and £1,000.
Credit Card or Store Card
Credit cards and store cards come under the umbrella of the UK loan market. With these, you are given a maximum credit limit.
You can use as much or as little of your limit as you like when borrowing money on a credit card. You can use the money to make purchases or pay bills.
You can repay what you owe and borrow the money all over again. Credit cards and store cards are ‘revolving credit’.
A credit card is used for more general spending, accepted by most retailers and companies. A store card is linked to a specific shop or chain of stores so that it can only be used to make purchases from that brand.
A bank account overdraft is a type of loan.
You might have an arranged overdraft, which has been previously agreed by your bank. Rates and charges for arranged overdrafts are typically relatively low.
Unarranged overdrafts have not been agreed by the bank. These occur when you don’t have an arranged overdraft at all, or you spend past your overdraft limit. These come with very high charges, in some cases up to £5 per day.
Buying on Credit
When you buy a product on credit, you receive the item before you have paid for it. You will usually have to put down a deposit. Your creditor provides the money up-front, directly to the seller, and you will then owe the creditor the remaining amount of money.
When you buy something on credit, you will be required to make monthly repayments until the loan has been paid off. Usually, people choose this option for large purchases such as home appliances, electronics or furniture.
Debt Consolidation Loans
A debt consolidation loan is used to repay other debts. If you are making separate repayments to a variety of lenders, you may wish to borrow one larger amount to repay all of your other creditors.
With a debt consolidation loan, you can make your debts easier to manage. You will only need to make one monthly repayment, rather than paying back multiple loans.
For a debt consolidation loan to be effective, you will need to be paying back less each month than you would otherwise be paying. For example, you might pay back £250 per month rather than £100, £150 and £50 per month elsewhere.
When you take out a debt consolidation loan you might need to extend the amount of time that you are in debt for and you could potentially owe more overall.
It is important to run through the numbers carefully as good debt consolidation should be used to reduce your financial liabilities – not increase them.
If you are unsure and find the figures confusing, try and get some advice from a friend or a professional who can help you to make the best decision.
If you are paying high rates of interest on other types of credit, including overdrafts, you may save money by consolidating your debts.
Debt consolidation can be risky
Often, consumers that consolidate their debts will continue to borrow elsewhere. This is one of the fastest ways to get into a spiral of debt.
If you are using a debt consolidation loan to pay off your credit cards, it is important to close those lines of credit and not to use your credit cards again.
Be aware that your other loans would all finish at different times if left alone, consequently freeing up some money. Using the example above you may be paying £300 per month currently, but if your £100 repayments ended next year then you would be continuing with only £200 of monthly debt repayments to make.
If you take out a consolidation loan, you could be making the £250 repayments over the full length of the new loan term with no reductions for paying off one line of credit.
The UK Loan Market in Numbers
- At the end of April 2016, people in the UK owed a total of £1.475 trillion.
- The average debt per household (including mortgage debt) was £54,636. Household debt is increasing by the year.
- Credit card debt makes up £64.4 billion of total UK debt. This is an average of £2,387 of credit card debt per household.
- UK adults are in an average of £29,210 of debt.
More information about debt advice can be can be found on the Money Advice Service website or Citizens’ Advice Bureau.