Loans are a way of borrowing money to make a purchase that could otherwise take a long time to save up for, such as a car, a holiday or a house. They can also be used to cover emergency spending – say your boiler needs repairing and you can’t afford to pay straight away or to consolidate more expensive debts.
Despite the vast choice of loans on the market, taking the time to carry out careful research will go a long way in helping you to choose the right type of loan for you.
A personal loan is a form of unsecured borrowing, which means that it is not secured by an asset, or collateral. Instead, it is simply an agreement between the lender and the borrower that the loan will be repaid each month over an agreed period of time.
Since they pose more of a risk to the lender if borrowers can’t repay, unsecured loans generally have a higher interest rate and lower borrowing limits than secured loans. The amount you can borrow tends to range from between £1,000 and £25,000, usually to be repaid over one to seven years.
Your credit score and overall financial situation will determine whether you’ll get a personal loan and what rate you’ll receive.
» MORE: What is an unsecured loan?
Although there is no asset to repossess, if you fail to repay an unsecured loan, the lender can attempt to claim the debt you owe through court action.
Some lenders will allow you to take out a joint loan, which means both parties are responsible for making sure the loan is repaid.
A secured loan is a loan that is backed by an asset, such as your home, car or other valuable item.
Since secured loans pose less risk to the lender than unsecured loans, they usually come with a lower interest rate. They can also often come with higher lending limits, depending on the value of the asset used as security.
» MORE: What is a secured loan?
If you fail to repay a secured loan, the lender can claim the asset you put up as collateral in order to recover the debt that you owe. In the event the amount you owe is more than the asset, it’s possible that you will be required to make up this additional amount.
Bad credit loans
Bad credit loans are designed for individuals who have poor credit scores or limited credit history that may prevent them from accessing lending products through more traditional routes.
Bad credit loans carry higher interest rates than loans for people with better credit scores, making them more expensive. They are sometimes offered by high street banks and building societies, but they are more commonly provided by smaller, specialist lenders.
Borrowers with bad credit may also be able to access loans from credit unions, guarantor loans, peer-to-peer lending and government budgeting loans – read on to find out more about these types of loan.
A payday loan is an unsecured short-term loan, usually between £50 and £1,000, designed to fill a financial gap before your next regular payment comes in – generally when you are paid by your employer.
While payday loans offer speed and convenience, they are a very expensive form of borrowing because interest rates will be significantly higher than other forms of lending. This could be hundreds or thousands of percentage points higher than most personal loans, credit cards, and overdrafts.
A guarantor loan involves a third party – such as a parent, legal guardian or employer – agreeing to meet the monthly repayments or pay off the loan completely in the event that the borrower defaults on the loan.
The guarantor will be legally bound to comply with the terms and conditions agreed to, and can be subject to court action and debt recovery measures if they fail to do so.
This arrangement can enable people with a poor or limited credit history to take out a loan if they are unable to do so through other routes.
Credit union loans
A credit union is a type of financial co-operative, which is run for the benefit of its members. Credit union members come together to support each other financially, including pooling their money to offer loans at low interest rates.
Members typically have something in common. They may live in the same area, work in the same industry or for the same employer, or belong to the same trade association.
Credit unions can offer unsecured loans, with a cap on the interest they are allowed to charge. This cap is 3% a month or 42.6% per year APR (annual percentage rate), except in Northern Ireland where it is 1% a month or 12.68% APR.
There are several different loans on offer at credit unions, including credit builder loans which can help people with bad credit or little to no credit history improve their score and build up their credit file.
Peer-to-peer lending is arranged through online platforms, where businesses or individuals can lend money to other companies or people who need to take out a loan, rather than using traditional financial institutions, such as banks and building societies. Lenders will then benefit from the interest paid by borrowers.
If you have an excellent credit rating, peer-to-peer loans can be cheaper than going through traditional routes. However, you may find it hard to access this type of loan if you have a poor credit rating.
Buy now, pay later loans
Buy now, pay later is a form of credit that is usually offered at the checkout – when shopping online, for example. It allows you to buy things that you may not be able to afford at the time, but with a commitment to pay by an agreed date.
These schemes are an increasingly common way of paying for purchases, by either deferring payment until a later date or paying in instalments. While the initial payments are interest-free, missed payments can incur hefty penalties and could lead to the involvement of debt collection agencies.
Student loans can help meet the cost of studying in higher education. There are two types of student loans: a tuition-fee loan paid directly to the college or university and a maintenance loan paid to you.
How much you can borrow will depend on your household income,where you are going to university and the length of the course. The process itself may also differ if you live in the UK, but outside England.
When you will start to repay your student loan, and the interest you owe, will depend on when you took out the student loan, whether you are employed, and how much income you earn.
Car loans and car finance
Although some providers will have specific car loans, most personal loans can also be used to buy a new or used car.
Car finance on the other hand, is a specialist form of finance that is typically arranged through vehicle dealerships. There are many car finance options with varying terms and conditions from hire purchase (HP) and conditional sale (as with HP, you don’t own the car until you’ve paid off the loan) to personal contract purchase and leasing. They typically require an upfront deposit followed by monthly repayments.
» MORE: Types of car finance
A logbook loan is a type of secured loan where your vehicle – such as a car, van or motorbike – is put up as collateral against the debt. These loans typically have high interest rates.
The logbook loan lender takes ownership of your vehicle until the loan is repaid. However, while the lender takes possession of the logbook and other ownership documents, the vehicle remains in your possession and is ‘loaned’ back to you so that you can continue to use it. When the debt is repaid, the ownership of the vehicle is transferred back to you.
Logbook loans are not available in Scotland.
Pawn shop loans
Pawn shops, or pawnbrokers, can offer loans to people based on the value of an item, such as jewellery, watches and electronics. The amount you receive will depend on how much the pawnbroker thinks the item you put forward as security is worth.
To get a loan, you will need to leave the item of value with the pawnbroker. You will get your item back as long as you have repaid the loan, with interest, by the end of the agreement. If you don’t repay the loan, the pawnbroker can sell the item to get their money back.
It can be relatively quick to receive a loan from a pawnbroker, but these loans can also come with high interest rates.
Home improvement loans
A home improvement loan is a loan taken out to pay for home improvement projects, such as a new kitchen, bathroom or extension. It could also include work such as upgrading your central heating, having a loft conversion, or landscaping your garden.
Home improvement loans can be either an unsecured loan, or secured loan. Another way to pay for home improvements is to get an advance on your mortgage.
Debt consolidation loans
Debt consolidation loans allow you to move existing borrowings into one loan so that you have just one monthly payment to make rather than several. It can be a way to move several debts with high interest rates to one loan with a lower interest rate. Debt consolidation loans can be either secured or unsecured.
While debt consolidation can sometimes make it easier to manage debts, you may also find that you end up paying more in total to clear the debt, particularly if you are extending the term of the loan to reduce monthly repayments. Careful consideration should be given to the costs involved.
If you have a poor credit score, then you mayight have to use your home as security for the loan, which could mean you risk losing your home if you fail to keep up repayments.
Government budgeting loans
A government budgeting loan can provide assistance if you are on certain state benefits and are struggling to afford an unexpected or essential cost, such as moving house, funeral expenses, travel, buying clothing and furniture, travelling costs in the UK, costs associated with finding a new job, and more.
If eligible, you can borrow as little as £100 or as much as £812. Budgeting loans are interest free, and repayments are taken directly from your benefits.
Some employers will offer their workers loans to help meet certain costs, usually relating to work. The most common employee loan is an interest-free annual season ticket loan to help with the cost of commuting.
It means that employees can take advantage of the discounted cost of a season ticket without having to pay up front. Instead, they will pay their employer back over the course of a year, with repayments generally deducted directly from their salary.
» MORE: How employee loans work
Business loans can range from as little as a few hundred to hundreds of thousands of pounds and are specifically designed for business use. Lenders will base the decision whether to approve a business loan application on a number of factors, including the business’s credit score, trading history and profitability.
A mortgage is a type of loan that helps you borrow money to buy a home. The loan is secured against the property you are buying.
You will generally need to put down a deposit of at least 5% towards the property’s purchase price. The rest will be repaid over a specific term, typically 25 to 30 years, but some can be as low as three years and up to 40 years. You will make monthly repayments, with interest, until the end of the mortgage term at a fixed or variable rate.
Mortgages themselves can come in many different forms. The above outlines the case for most people buying a home to live in and is often referred to as a repayment mortgage. You may also see various other mortgage types, which work slightly differently – for instance, interest-only or offset mortgages.
A bridging loan, also sometimes called a bridge loan, is a loan that will cover a short-term financial gap when you know that the money you need will be available in the near future.
A bridging loan can be used to bridge the gap between a purchase and the funds being made available to you for that purchase – for example, if you want to buy a home before the sale of your current home has completed.
As bridging loans are short-term financial instruments, interest is usually charged monthly rather than annually and these loans tend to attract higher rates than long-term loans. There are also set-up fees to consider.
A bridging loan is a secured loan, which means your property or asset is at risk of being claimed by the lender if the funding you were expecting fails to come through. This means bridging loans can be expensive and you’ll need to take extra care planning how to fund the repayment of the loan.
What to consider before applying for a loan
Now you know the types of loan that are available, it’s important to make sure you choose the right loan if you decide to borrow money. To help you choose, you should consider the following points:
- How much do you want to borrow?
- How much does the loan cost, including interest and any fees?
- How soon do you need the money?
- What do you plan to use the loan for?
- How long do you need to repay the loan?
- Do you want a secured or unsecured loan?
- How much can you afford to repay each month?
- Are you eligible for a loan?
- Can you improve your credit score to help your loan application?
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Dive even deeper
Three in five UK adults have asked to borrow money from their friends or family, with more than a third needing it for a bill, a new survey has found. Find out more about this hidden world of borrowing and how it can go wrong.