If you want to borrow between £1,000 and £3,000, your main options are a personal loan, credit card, or overdraft.
If you have a poor credit history, you’ll find it more difficult to borrow money. You should also think very carefully before choosing other options, such as a guarantor or short-term loans, as these types of borrowing are expensive.
Here’s a guide to taking out a small loan along with what to watch out for..
Personal loans are normally available for amounts from £1,000 up to £25,000. Payment terms vary from loan to loan but normally run between one and seven years. You’ll pay the loan back monthly, with interest, via fixed payments.
The longer you take to pay back your personal loan, the lower your monthly payments will be. But a longer term means you’ll end up paying more interest overall.
How much you can borrow and the interest rate you’ll be offered will depend on your personal circumstances and your credit rating. Interest rates typically range from about 3% up to about 15%.
The interest rate you pay can vary depending on how much you borrow. ‘Tiered rates’ mean the interest rate decreases the larger the loan you want to take out. Interest rates might be uncompetitive on amounts less than, say, £7.500.
Personal loans are often advertised with low headline rates that can make them look very cheap. But, legally, the loan company only has to offer the advertised rate to 51% of successful applicants – so you could be offered a higher rate.
If you own your home, you can normally get a cheaper personal loan by opting for a ‘secured’ loan (rather than an unsecured personal loan) or a ‘homeowner’ loan. In this scenario, the loan will be secured on your property. Although usually cheaper, these loans are risky as you can ultimately lose your home if you fail to make repayments on time.
If you want to borrow a relatively small amount, it might be cheaper to borrow on a credit card rather than take out a loan.
Standard credit cards normally have an annual percentage rate, or APR, of around 18%. But some cards offer introductory offers where you pay 0% interest on purchases for a set number of months. These so-called ‘0% purchase’ credit cards are the cheapest way to borrow.
Credit cards are a form of ‘revolving credit’. You can borrow, and pay back, any amount up to a pre-set credit limit.
Credit cards are much more flexible than loans as they don’t have fixed repayments. You’ll need to pay back at least the minimum repayment each month, but beyond that it’s up to you how much you pay.
This can be great as you can pay your debt off quickly if you can afford to, or pay less some months if money is tight. But on the downside, without the discipline instilled by fixed repayments, you may take a long time to repay a debt, incurring more interest all the time the debt is outstanding.
With an overdraft you can borrow from your bank account by taking your balance below zero. When you’re in your overdraft you’ll see a minus (-) sign on your bank statement or the letters “OD”.
Overdrafts can be quick to arrange – you may already have an overdraft facility in place. In other cases your bank can add an overdraft facility the same day.
Like credit cards, overdrafts are a form of ‘revolving credit’. You can borrow, and pay back, any amount up to a pre-set credit limit, without having to stick to set repayments.
A rule change from the City Watchdog, the Financial Conduct Authority, means that banks must scrap fixed fees and charge a single interest rate for all overdrafts. The result of the rule change has been that most banks now charge 35% to 40% on overdrafts – so, by comparison, they are much more expensive than credit cards or personal loans.
If you have a bad credit history or don’t own a property, you might find it difficult to be approved for a personal loan or credit card. But in many cases, you’ll be eligible for a guarantor loan.
The crucial difference between a guarantor loan and a personal loan is that a guarantor acts as a back-up to the loan and agrees to cover the debt if you default on repayments.
The guarantor is normally a parent or close friend. Having them on board reduces the risk to the lender, so it may be happy to lend you the money when you’d be rejected otherwise.
But guarantor loans are expensive, with typical APRs of about 50%.
Anyone you ask to be your guarantor should think carefully before agreeing. This is because they might have to pay back the loan if you can’t or don’t. If the loan remains unpaid, it may affect the guarantor’s credit score as well as the borrower’s.
Your guarantor being called upon to repay your debt is also likely to affect your relationship with that person.
Payday loans and short-term loans
Payday loans can be easy to get – but they can be cripplingly expensive. With a payday loan, minimal checks are carried out and the money is usually paid into your bank account within hours.
The idea is you repay the money when you get paid. For most people this will be at the end of the month. So most payday loans are repaid within a matter of days or a couple of weeks.
The typical charge is about £24 for every £100 borrowed for 28 days. But costs can add up quickly if you don’t repay your loan on time. This might not sound too bad but it often equates to an APR of well over 1,000%.
Financial regulators have clamped down on payday loans over the past few years as lots of people were borrowing money they couldn’t afford to repay. Since then, some lenders have started offering short-term loans repaid over six or 12 months. These loans often have high interest rates too.
Weighing up your loan options
Whatever small loan option you choose, it’s important to make sure you can afford the repayments.
In general, the longer the term over which you repay a debt, the more interest you’ll end up paying. So paying off your debt quickly will save you money.
If you have a good credit history, you’ll find it easier to find a cheap loan or 0% purchase credit card. But if you have a poor credit record, your options will be more limited.
Whatever type of loan product you see advertised, only 51% of successful applicants need to be offered the headline rate. If you’re not offered the rate you want, you are free to turn down the offer and carry on looking for a loan elsewhere.