Whether you’re looking to buy a car, revamp your kitchen, go on holiday, or simply consolidate your existing debts, taking out a loan allows you to split the cost into affordable monthly payments spread over a year or more.
There are two main types of loan to choose from:
Unsecured loans, also known as personal loans, which are based on your income and credit score
Secured loans, which are lent against an asset such as a house or flat
For smaller purchases, most people choose unsecured loans.
However, if you have a low credit score, you may find it easier and cheaper to take out a secured loan.
Find out which type of loan is right for you with our quick guide.
What is an unsecured loan?
With an unsecured loan, you borrow a set amount from a bank or lender and make fixed monthly payments until that sum – plus interest accrued at the agreed rate – is paid in full.
Most personal loans can be taken out over between one and seven years, although some stretch to 10 years or more.
Borrowing over a shorter time frame means making larger monthly payments; borrowing longer term can allow you to make lower payments, but will usually cost you more in interest overall – even if you are charged a lower rate.
That’s why it’s always a good idea to compare unsecured loans by their total cost rather than simply by the interest rate you’re quoted.
Borrowing £5,000 over three years at an interest rate of 7% will cost you a total of £540.20.
Borrowing £5,000 over five years at an interest rate of 6% will cost you a total of £777.69.
The amount you can borrow via an unsecured loan, as well as the interest rate you are charged, will depend on your financial circumstances.
Lenders price loans based on how much risk they believe there is of you failing to keep up with the repayment schedule.
So if you have a good income, and your credit file indicates that you always pay your bills on time, you’ll generally be offered a better interest rate than someone who has missed repayments in the past or has an uncertain income stream.
That’s why many of the cheapest personal loans are only available to full-time employees with high incomes and high credit scores.
It’s also why, if you have a low credit score and/or a low income, you’re unlikely to be approved for an unsecured loan with an attractive interest rate.
Unsecured loans: advantages
You can borrow as little as £1,000 – although you may find you are offered a lower interest rate when you borrow at least £3,000
Unsecured loans are quick and easy to set up – in some cases you can get the money within a week
Knowing exactly how much you have to pay each month makes budgeting easier
You can often pay off unsecured loans early free of charge – although you may have to pay a fee of up to two months’ interest
You can shop around for the best deal – there’s lots of competition in the unsecured loan market, and the interest rates available vary widely
Unsecured loans: disadvantages
You will often be refused an unsecured loan if you’re on a low income or have an irregular income stream
It can be difficult to get an unsecured loan if you’re self-employed
Your credit score will go down (and you could face court action) if you fail to make unsecured loan repayments on time
You may be asked to pay a higher interest rate than the one advertised, as lenders only have to offer the “representative APR” to just over half of borrowers
Unsecured loans: alternatives
Credit cards: it may prove cheaper to borrow the money you need on a credit card – especially if you can qualify for a card that charges 0% on purchases or balance transfers
Secured loans: these offer another way to borrow money if you own your own home, or have another asset you can provide as ‘security’
What is a secured loan?
Unlike unsecured loans, secured loans require you to have a valuable asset – usually a property – that you can use as security. That’s why they’re also sometimes known as homeowner loans or second mortgages.
In effect, this means that if you fall behind on your loan repayments, the lender can claim back the value of the loan by forcing you to sell your home – or whatever asset the loan is secured against.
So taking out a secured loan is a risky move if you think there’s a chance you could become unable to meet the repayments.
On the plus side, secured loans often come with lower interest rates than unsecured loans; the rate is lower because the lender is taking on less risk.
They can also often be used to borrow larger amounts. How much will depend on your level of income, as well as the value of the asset you are offering as security.
Secured loans: advantages
It’s easier to take out a secured loan if you have a less-than-perfect credit history
You will often be offered a lower interest rate than with an unsecured loan
Even if you can qualify for an unsecured loan, taking out a secured loan may help you secure a larger sum
Secured loans: disadvantages
You could lose your home – or whatever asset you’ve put up as security – if you don’t keep up with your repayments
Some secured loans have variable interest rates, meaning your repayments could increase if rates go up
You may have to pay an arrangement fee or other related charges
Secured loans: alternatives
Remortgaging: if you have a mortgage, you may be better off using the equity in your home to borrow more money that way
Guarantor loans: even if you can’t get an unsecured loan, you may be able to take out a guarantor loan if you have a relative or friend willing to guarantee your payments