Guide to Loans

Types of loan

There are two types of loan - unsecured and secured - that differ mainly because of the amount of money involved. These types of loan can vary hugely, however, and the difference in interest between two unsecured loans (a credit card and a payday loan, for example) can be enormous.

What is an unsecured loan?

By far the most common type of loan is the unsecured loan. These include your overdraft, credit cards, payday loans and store cards. ‘Unsecured’ means that these loans do not put your property at risk: they do not need to be backed up with something of worth.

What is a secured loan?

Secured loans, by contrast, are typically for a larger sum, with specific loan terms, and require some large collateral, such as property, to be provided as security. As such, defaulting on a secured loan will put your home at risk.

Loan interest rates

The rate you will be charged for a personal loan will depend on the size of the loan, the agreed length, any existing lender relationship and your creditworthiness. It is essential that you understand how credit scoring agencies work and how a history of unpaid debts will damage your credit rating and make it harder and more expensive for you to borrow. For more information on this see our credit scoring guide.

When looking for a personal loan, remember that loan interest rates advertised are the ‘representative’ rate offered by lenders to a certain percentage of borrowers, and may not be the  rate you are actually offered. The advertised loan interest rates are usually only available to customers with a very high credit score rating.

Getting the best loan interest rates

Once you understand the types of loan available, you need to decide how much you want to borrow and over what period. Most lenders have tiered rates of interest, which can mean- that you get a lower rate of interest if you borrow more. A further consideration is the term (or duration) of the loan, as this can affect the interest rate you are charged.

Lower loan interests for higher sums borrowed doesn’t mean you should borrow more than you need, just that you should be aware that by borrowing £5,000 you might pay a lower rate than if you borrowed £4,900. Typically, the lowest loan interest rates only apply when you borrow £7,500 to £10,000.

Loan terms

Different lenders offer different terms for their unsecured loans, with typical loan terms ranging from one to seven years (although some companies will offer as little as 1 month, or up to 10 years). At the outset, you can decide the period over which the loan is to be repaid but remember that personal loans can levy early repayment charges if you want to pay the loan off early. There may be restrictions on the length of loan terms. For example, if you are approaching the normal retirement age, then you may only qualify for a shorter term.

As well as basing their decision on whether to grant you a loan on your credit score, the lender will look at your existing debts and at your ability to repay the loan given your other financial commitments.

Personal loans make most sense for people who want to repay their debt over a few years. If you want to pay off a purchase over six months, buying it with a credit card or an overdraft may work out cheaper.

Payment protection insurance (PPI)

Payment protection insurance (PPI) is a policy that covers your repayments on loans and credit cards if you fall into financial difficulties as a result of accident, sickness or unemployment. It is sometimes referred to as accident sickness and unemployment cover (ASU).

From April 2012 lenders cannot sell you payment protection insurance when you take out a loan, but may do so shortly thereafter. If you want PPI then it is always worth shopping around for the policy that best suits your needs in terms of coverage and cost. It is also worth checking on how long your employer will cover your payment in case of emergency, and whether the provider’s PPI would actually cover you. For guidance and advice on whether PPI may provide useful protection, take a look our guide to payment protection insurance.

What does it mean if I am refused a loan?

Lenders will run a credit check on any potential borrowers, as well as checking them against their own records. If you are refused a loan, it is possible that your credit rating is low. For more advice on how credit scoring works, have a look at our credit scoring guide.

It is worth remembering that different lenders have different criteria and scoring systems, so an application to another lender may prove successful. A refusal may be down to a recent change of address or employment status.

Try and avoid applying for lots of loans because details of your application will appear on your credit reference report even if you are rejected or do not proceed with the loan.

Getting a loan is a big step, and not one that should be taken lightly – but consulting our guide to loans should have given you a clearer idea of what risks are involved.

Top tips when seeking a loan

• Before you talk to anyone, work out how much money you want and how long you need to pay it back – remember, shorter term loans can save you money.
• Have a look at the loan terms and rates of interest, as borrowing slightly more could reduce the interest rate you pay.
• Consider a credit card or overdraft for really short term loans. Different types of loan suit different needs.
• Consider whether PPI is appropriate for your circumstances, and don’t get it if you don’t need it.
• Don’t panic if you’re application is refused – try to find out why.
• Many banks and building societies offer preferential rates to existing customers - approach your own bank or building society when choosing a loan to see if it has a competitive loan available.
• Supermarkets are also prominent in the personal loans market, as well as offering competitive rates they may also offer other incentives like reward points.
• Finally, if you are happy to apply for a personal loan by telephone or online then you may get a lower interest rate than if you visit a branch of your local bank or building society. 

It is really important to get the right loan, as the wrong choice could end up costing you money. By following the advice in this guide to loans you should ensure that you find a loan which meets your needs.