Need to borrow money and repay a fixed amount each month, for a set period? A personal loan could be just the answer. This guide explains all you need to know before taking the plunge with a personal loan, including how you can ensure that you get the best and most suitable deal for your circumstances. So what are personal loans?
What are Personal Loans?
A personal loan is an amount of money provided by a bank or alternative financial provider. It is a form of credit that is typically unsecured. This means that the creditor does not ask for collateral, such as your house (as with a home buyer’s loan) or your car (as with a logbook loan) to secure your loan against. Another term for a personal loan is an unsecured loan or an instalment loan.
While the demand for unsecured finance is falling, in the final three months of 2015 banks, credit unions and other financial providers drew down £4 million of unsecured personal loans – representing a real surge in demand for this form of credit.
Source: Step Change Report
Personal Loans – The Advantages & Disadvantages
Similarly to any other form of credit, personal loans are subject to advantages and disadvantages. The following summarises the main pros and cons of personal loans.
Advantages of a personal loan
- You may be able to access more funds than other credit products (e.g. a credit card)
- Your repayments will be fixed each and every month, which can assist your financial management
- Your interest rate will likely be fixed – it’s worth noting that some lenders work on variable rates – always check the small print
- You can select how long a loan term you’d like – remember, choosing higher repayments will allow you to pay the loan off quicker, while lower, more affordable repayments stretch out over a longer period, resulting in more interest
- You can roll numerous debts into a single personal loan, and in the process reduce your monthly outgoings (and as the average cost of credit card lending was 18.48% in February 2017, the potential savings can be significant)
- You can make over-payments to repay your debt more quickly
- You can also repay early and recoup some of the interest you would have paid if the loan had run to full term
Disadvantages of a personal loan
- Personal loans have higher interest rates than some other forms of credit (such as secured loans); this is especially true if you want to borrow a relatively small amount
- As the interest rate that is offered is sometimes lower for higher amounts, you may be tempted to borrow more than you truly need
- The majority of high street banks won’t lend less than £1,000 over a period of 6 months. This too can mean that you borrow more than you can afford.
How does a personal loan work?
Here’s a visual overview of how loans work, and for an in-depth guide read our article: How Do Personal Loans Work?
Savvy Borrowing Tips: What to Check When Applying for a Personal Loan
Personal loans and the cooling-off period: Know your rights
Every personal loan, no matter the provider, must come with a 14-day cooling off period. This runs from either the date of the loan agreement or the date that you receive a copy of the loan agreement (whichever comes later). If you choose to cancel the loan within the 14 days, you then have 30 days to repay the credit, and you’ll only be charged the interest that applies to that period.
Carefully consider insurance products
PPI products were regularly sold in the past and often mis-sold to people that didn’t really need them, yet insurance products for loans can and do have value if you fall ill and can no longer work. Our advice? Be in the know – research potential insurance products thoroughly and always get to grips with how much the coverage in question will cost.
Always ensure that you can afford the repayments
Create a household budget sheet to understand your current financial standing and how a personal loan will change your outgoings (this is particularly important if you’re consolidating your debts, as you should be certain that you’ll be in a better financial position after the personal loan). You may want to begin by reading our guide on How to write and manage an income budget properly.
You may not receive the advertised APR
APRs that feature on adverts show the ‘representative’ APR – the rate that applies to 51% or more of applicants, so you may not qualify for the advertised rate.
If your credit rating is blemished, you should expect to pay more in interest – lenders see you as a bigger risk compared to those with a perfect credit record.
Getting the Best Personal Loan Deal – Three Essential Pointers
1 – Review your credit history before you apply
Regularly reviewing your credit history is important not only for being a responsible borrower but also for staying alert as to the potential theft of your identity (a crime that’s currently experiencing an unprecedented rise). Read our guide on credit scores to see whether there are some simple steps you can take to improve your credit score before applying for a loan.
2 – Always shop around
Don’t simply approach a single high street lender and accept the very first deal that you’re offered. This is where a broker can help, as they act as a knowledgeable middleman that can connect you with many providers at once.
A word of warning: Beware approaching too many standalone financial providers. Each credit search will leave an imprint on your credit file, and if too many are undertaken this can give the impression that you’re applying for masses of credit (another reason why it makes sense to use a broker).
3 – Always compare the total cost of the loan – look at the APR interest rate
You’re on the lookout for the best interest rate possible, and this will be detailed by the APR rate of a product (which includes any additional fees, such as an arrangement charge), rather than just the interest rate.