A personal loan lets you borrow a set amount and repay it over an agreed period. You normally make fixed monthly payments until the loan is cleared.
Personal loans are usually unsecured, so they are not secured against your home. However, missed payments can still have serious financial consequences.
How Do They Work?
You borrow money from a lender and agree to repay it over a set number of months or years.
Most personal loans have a fixed interest rate. This means your monthly payment normally stays the same throughout the loan, making it easier to plan your budget.
At the end of the term, the loan should be fully repaid if you have made all the required payments.
What Can You Borrow For?
Personal loans can be used for many purposes, such as a car, home improvements or another large purchase.
They can also be used to combine existing debts, although this needs careful thought.
Some lenders restrict how their loans can be used, so check the terms before applying.
How Much Can You Borrow?
The amount available depends on the lender and your circumstances.
A lender may look at your income, spending, existing debts and credit history before deciding how much it is willing to lend.
However, the maximum available is not necessarily the amount you should borrow.
Start with how much you actually need.
What Will It Cost?
The cost depends mainly on:
- how much you borrow
- the interest rate
- how long you borrow for
- any fees or charges
A longer term can reduce your monthly payment, but it can also mean paying more interest overall.
So, compare both the monthly payment and the total amount repayable.
What Is APR?
APR stands for Annual Percentage Rate. It helps you compare the cost of different loans by including the interest rate and certain charges.
However, an advertised representative APR is not a promise that you will receive that rate.
The rate you are offered can depend on your circumstances and the lender’s checks.
Once you receive an offer, look at the actual APR and total amount repayable.
Choosing the Loan Term
A longer loan can make the monthly payment smaller, while a shorter loan normally means paying more each month.
For example, spreading the same debt over five years instead of three can make it look more affordable. However, you may pay interest for another two years.
Choose the shortest term that gives you payments you can comfortably afford.
Check Your Budget
Before borrowing, work out what you have left after your normal household costs and existing debts.
Do not assume that a lender offering you the money means the repayments will be comfortable.
Also think about what would happen if your circumstances changed. A payment that is easy to manage today may become harder if your income falls or your costs rise.
Your Credit History
Lenders can use information from your credit record when deciding whether to lend and what rate to offer.
So, it can be useful to check your credit reports before applying and correct any mistakes.
Remember, there is no single credit score used by every lender. Different lenders have their own ways of assessing applications.
Check Eligibility First
Some lenders and comparison services let you check your chance of being accepted before making a full application.
Where possible, check whether this uses a soft credit search.
A soft search does not normally affect your credit record in the same way as a full application. This can help you explore your options without making several full applications.
Secured or Personal Loan?
A personal loan is normally unsecured. This means your home is not directly used as security for the debt.
A secured loan, by contrast, is usually secured against an asset such as your home.
That difference matters because failing to repay secured borrowing can put the asset at risk.
However, unsecured does not mean risk-free. Missed personal loan payments can lead to extra costs, damage your credit history and result in action to recover the debt.
Can You Repay Early?
You may decide to clear the loan before the agreed end date.
Doing this can reduce future interest, although an early repayment charge or other amount may apply in some cases.
Ask the lender for an early settlement figure. This tells you how much you need to pay to clear the loan.
Then you can decide whether early repayment makes sense.
Using a Loan for Debt
A personal loan can sometimes be used to combine several debts into one.
This may make your finances easier to manage and could reduce the cost if the new borrowing is cheaper.
However, do not judge it only by the new monthly payment.
If you repay the new loan over much longer, you could end up paying more overall. You could also make matters worse if you clear credit cards and then start borrowing on them again.
Compare the total cost before and after.
Loan or Credit Card?
A personal loan can work well when you need a fixed amount and want a clear repayment schedule.
A credit card works differently because it offers a reusable credit limit rather than one fixed loan.
Which costs less depends on the amount borrowed, the interest rate, how quickly you repay it and any fees.
For larger borrowing over a set period, the predictable payments of a personal loan can make budgeting easier. For smaller or short-term borrowing, other options may sometimes cost less.
Always compare the actual cost.
Avoid Borrowing More
A lender may offer more money than you originally planned to borrow.
That can be tempting, particularly if the monthly payment still looks manageable.
However, the extra money is not free. You will have to repay it and usually pay interest on it too.
Borrow for a clear reason rather than simply because more credit is available.
If You Are Refused
Being refused by one lender does not necessarily mean every lender will refuse you.
However, avoid immediately making several more applications.
First, check your credit reports for errors and consider whether your income, existing debts or other commitments may be affecting the decision.
Eligibility checks can then help you explore possible options before making another full application.
If You Cannot Pay
Contact your lender as soon as you know you may struggle with a payment.
Acting early can give you more time to discuss your options.
If you have several debts and cannot keep up, free debt advice can help you look at your finances as a whole.
Avoid taking another expensive loan simply to keep up with the first one.
Before You Borrow
First, decide exactly how much you need and whether borrowing is necessary.
Next, check that the monthly payment fits comfortably within your budget. Then compare the APR, term and total amount repayable.
Finally, read the agreement before accepting it.
A good loan decision is not about getting the largest amount or the smallest monthly payment. It is about borrowing only what you need at a cost you can afford.
Key Points
- Personal loans are normally unsecured.
- Borrow only what you need.
- Compare the total amount repayable as well as the monthly payment.
- A longer term can reduce the monthly payment but increase the total interest.
- The representative APR may not be the rate you receive.
- Check your budget before applying.
- Contact your lender early if you struggle to repay.
Important Information
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