Different Types of Loans: Which is Best for Your Needs?

Looking to take out a loan but don’t know where to start? Read on to get the lowdown on the different types of loan to consider, depending on how much you want to borrow, what you need the money for, how high interest rates might be and how quickly you’d like to be debt-free.

Sarah Bridge, Joel Kempson Last updated on 16 May 2022.
Different Types of Loans: Which is Best for Your Needs?

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.

In general with a loan, you sign an agreement committing yourself to pay the sum borrowed, plus interest, over a fixed period of time. Product features such as interest rate, duration of the loan, eligibility criteria and methods of repayment could differ from loan to loan and can change depending on the type of loan you take out and your own individual financial circumstances.

Some key considerations when looking at loans are whether you want your loan to be secured or unsecured, as well as understanding whether it has a fixed or variable interest rate. You may also find that you need a specific type of loan product for your desired use, or a bad credit loan if your credit history is particularly poor. Before making your choice, read on for a quick guide to the main groups and types of loans.

Fixed-rate loans

A fixed-rate loan is a loan that has a fixed rate of interest throughout the term of the loan.

A fixed interest rate gives you the security of knowing that, whatever happens to interest rates in the future, such as a change to the Bank of England’s base rate, the interest on your loan will not change. This means your repayments will stay the same every month.

» MORE: Fixed-rate borrowing explained

Variable rate loans

Variable rate loans work in the opposite way to fixed-rate loans. If interest rates fall, then the interest rate on your variable rate loan may fall too.

Equally, if interest rates rise, your loan could become more expensive. This means your monthly repayments could rise and fall with rate adjustments.

» MORE: What is a variable interest rate?

Secured loans

A secured loan is a loan that is backed by an asset, such as your home, car or other valuable items.

Because 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 could be required to make up this additional amount.

» COMPARE: Secured loan rates and deals

Unsecured loans

An unsecured loan, also called a personal loan, is a form of borrowing that 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.

Because 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.

» 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.

» COMPARE: Unsecured loan rates and deals

Short-term loans

Short-term loans refer to the lending of relatively small amounts, over a matter of weeks or months. A payday loan is an example of a short-term loan.

Short-term loans can be used by borrowers looking for a quick loan to meet a funding gap or to cover an unforeseen emergency. Short-term loans are not designed for long-term borrowing because the interest rates attached to these products can be significantly higher than with traditional personal loans.

» MORE: Short-term vs long-term borrowing

Payday loans

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, often hundreds or thousands of percentage points higher than the most competitive personal loans, credit cards, overdrafts and credit union loans. As such should only be used when other options are not available and you are very confident you can repay the debt in full.

» MORE: Understanding payday loans

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.

» MORE: How to get a loan with bad credit

Bad credit loans carry higher interest rates, so they are 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.

» COMPARE: Loans for borrowers who have bad credit

Buy now, pay later loans

Buy now, pay later loans are usually offered at the checkout – when shopping online, for example. They allow 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.

» MORE: Know the dangers of buy now, pay later schemes

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.

» MORE: Credit unions explained

Guarantor loans

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.

» MORE: Getting a guarantor loan

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.

» COMPARE: Find guarantor loans

Peer-to-peer lending

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.

» MORE: The pros and cons of peer-to-peer lending

Business loans

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.

» COMPARE: Business loan rates and deals

Mortgages

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.

» MORE: What is a mortgage?

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 3 years and up to 40 years. You will make monthly repayments, with interest, until the end of the mortgage term at a fixed rate 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 mortgages or offset mortgages.

» COMPARE: Mortgage rates and deals

Bridging loans

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 – hence the name – 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.

Bridging loans can be ‘closed’ or ‘open’ depending on what is best for your circumstances. A closed bridging loan will come with a fixed repayment date while an open bridging loan will have no fixed repayment date but is typically for up to one year.

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 all means bridging loans can be expensive and may require you to take extra care with how you plan to fund the repayment of the loan.

» MORE: Bridging loans explained

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.

» MORE: Understanding home improvement loans

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 typically arranged through vehicle dealerships. There are many car finance options with varying terms and conditions from hire purchase and conditional sale to personal contract purchase and leasing. They typically require an upfront deposit followed by monthly repayments.

» MORE: The different types of car finance options explained

Logbook loans

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.

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.

This form of logbook loan is not available in Scotland.

» MORE: Understanding logbook loans

Student loans

Student loans can help meet the cost of studying in higher education. There are two types of student loan: 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 in the UK you live, where you are going to university and the length of the course.

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.

» MORE: What you need to know about student loans

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 loans 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.

» MORE: Understanding debt consolidation

If you have a poor credit score, then you might 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.

» COMPARE: Debt consolidation loans for borrowers with bad credit

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.

» MORE: How government budgeting loans work

Employee Loans

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

Image source: Getty Images

About the authors:

Sarah Bridge has been writing about business and finance since 2000. She was formerly Deputy Editor, Personal Finance, The Mail on Sunday and was previously the paper's Leisure Correspondent. Read more

Joel Kempson is a personal finance expert and writer at NerdWallet. He has previously written for Money.co.uk and Uswitch, as well as being quoted in the Daily Express, The Mirror and The Sun. Read more

If you have any feedback on this article please contact us at [email protected]