Personal loans: the basics

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Personal loans can be an affordable route to raising cash for all manner of expenses. Uses for an unsecured loan can include funding a new car, home improvements or even a wedding or once-in-a-lifetime holiday.

Sometimes a loan can be the answer to consolidating costly credit card balances and may save you money in the long term.

A personal loan can be a cost-effective solution as low interest rates means that borrowing is relatively low-cost. While loans are readily available on the high street and online, taking one out means signing a legal contract, so it’s important to make sure you understand exactly what you’re taking on.

How does a personal loan work?

You can borrow anything from £1,000 up to between £25,000 and £30,000 via a personal loan, and sometimes more if you are an existing customer with the bank.

However, interest rates, which are expressed as annual percentage rates (APRs) are tiered according to how much you borrow. Typically rates are much higher on loans below £7,500, so for much smaller amounts it could make sense to weigh up other types of borrowing such as 0% credit cards or overdraft.

While it may seem counterintuitive, if you are plumping for a loan, it might even work out cheaper to borrow slightly more than you intended.

For example, if you want to borrow £7,400, a loan of £7,500 (the threshold where the lowest APRs on loans kick in) could make the borrowing cheaper overall. But do your sums first, with the help of an online calculator, to be sure this is the case.

At the other end of the scale, if you want to borrow more than the maximum offered from a personal loan you will need to put down security, such as your home and take a secured loan instead. This is not a decision to be taken lightly as it means your home is at risk. It also isn’t an option for everyone – renters for example.

You can choose how long you’d like to take to repay a personal loan. Most loans run from 12 months up to seven years with the rate fixed, so that you know exactly what you’re paying each month. Always check though, as some loans could be offered on a variable rate of interest which could go up and down.

Generally, the longer the loan term you choose, the lower monthly payments will be but the more overall you will pay in interest.

Related: Compare Loans & Find The Right Deal For You

What are loan providers charging?

Representative APRs on the very cheapest personal loans are currently priced at under 3%. But deals vary over time according to the market. Advertised APRs are also ‘representative’ meaning they must only be offered to 51% of accepted applicants.

When you apply for a loan, lenders will assess your credit worthiness by checking your credit history, which will highlight any missed or late payments.

Any such blemishes will most likely impact on the interest rate you are offered should your application be accepted. So you might not actually get the interest rate you see advertised. If you have a history of late or missed payments, you are likely to be offered a higher APR.

Your credit score will impact whether the loan application is approved and the final interest rate that is offered. Once you get through the application process you will get confirmation of the rate you are going to be charged.

Importance of shopping around

Taking the time to think about the best loan for you and to compare credit deals could save you a substantial amount of money. Don’t just apply to your bank, for example, as it is unlikely to offer the lowest rate on the market.

Use a comparison website to make sure you find the cheapest rates on the market, and from a provider you trust.

Don’t make a handful of applications with the view to choosing the cheapest offer. Making several applications you may damage your credit score and be forced to pay a higher rate, or even be refused credit entirely.

This is because if a lender can see that you have been making lots of applications for loans they may assume that you are desperate for cash which puts them off offering you a loan.

However, if you use an eligibility checker, this will carry out a ‘soft search’ instead. It means you can see how likely you are to be accepted for a personal loan before you apply, and won’t leave a footprint on your credit file.

Once you have found an affordable loan you can apply online and the money can sometimes land in your designated bank account on the same day. It all depends on the lender and how quickly your application can be processed.

Change in circumstances

As part of the loan agreement, you commit to making the stated monthly repayments for the term of the loan. If this looks set to becomes difficult, it’s important to talk to your lender before you miss any.

Not repaying a loan impacts your credit score whether you miss one or multiple payments. A missed payment will be marked on your credit report, which means other lenders will see you have failed to keep up with a loan. This will reduce your chances of being approved for credit cards and loans in the future, as well as rental agreements or even a mobile phone contract.

However, if a missed payment is agreed with your loan provider – such as a pre-approved payment holiday – it will not create a blemish on your credit profile.

Whatever your circumstances, don’t bury your head in the sand. Lenders can agree to restructure the loan, agree smaller payments for a time, or offer a complete break from payments until you get back on your feet.

Scam alert

Should you decide that a personal loan is for you, be on your guard. There’s a growing scam involving personal loans that could leave you seriously out of pocket.

Fraudsters contact you out of the blue and offer you a loan. The sting in the tail is they ask you to pay an advance fee to release the funds. You will likely be told that the fee is refundable and will be used as a deposit or administrative fee to guarantee the money. It might be just a few pounds, though in some cases, scammers have demanded a string of fees, adding up to hundreds of pounds.

Not only will the scammers walk away with your money, they also routinely steal your card details used to make the payment. There is of course, no loan at the end of it.

A genuine loan offer will never require a payment to activate the loan and, if you take out a loan with an unauthorised firm, you won’t be covered by the Financial Ombudsman Service if things go wrong.

Related: Compare Loans & Find The Right Deal For You

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